By DeVry University
December 14, 2022
5 min read
December 14, 2022
5 min read
Accrual accounting is a term you may have heard but its meaning remains a bit murky. Businesses of all types and sizes need to use different accounting methods to track their finances, get a clear picture of their cash flow, compare their financial performance over multiple accounting periods and determine what taxes are owed. Without being familiar with what this term means, it might be hard to see why it’s so important.
In this article, we’ll provide a detailed answer to the question: What is accrual accounting? We will also discuss how it works, its benefits, some of the different types of accruals and how accrual accounting differs from cash basis accounting.
Deferred revenue: Also referred to as unearned revenue, this type of accrual is recorded when a business receives cash before a good is delivered or a service provided. It goes on the balance sheet as a liability because the company is obligated to deliver the goods, or the services, in the future.
Accrued revenue: In this accrual type, the business has delivered the goods or services, but hasn’t yet received payment. Accounts like these are typically seen in long-term projects or loans where milestones are established and met.
Prepaid expenses: This account is created when a company pays up-front for something before the good or service has been provided. It’s an asset account because it shows the company is entitled to receive the goods or services in the future.
Accrued expenses: Also known as accrued liabilities, accrued expenses occur when a company incurs an expense and hasn’t been billed for it yet. In this case, the company has received the merchandise or service and will pay for it in the future and in the meantime the expense is an accrued liability.
By using accrual accounting, companies can look at both current and expected cash flows, providing a much more accurate picture of the organization’s financial health.
Accrual accounting shows underlying business transactions, not just those involving cash. Many transactions may be relatively straightforward, with payment received or made at the time of the transaction. Other transactions, which may be more complex, involve buying and selling on credit. This requires the company to account for monies that will be paid or received in the future.
Accrual-based accounting is likely to be more accurate regarding a company’s assets or liabilities. Adhering strictly to a cash-basis system, a company’s accounting may leave out crucial information regarding unpaid invoices or liabilities, which could cause the omission, however unintentionally, of certain assets.
The timing of when revenues and expenses are recognized can have a major effect on a company’s perceived financial health. One example of this can be found in the construction business, where a company may take on a long-term project and not receive cash payments until the project is completed.
Using the accrual method, a company would benefit from something called the percentage of completion method, in which the construction company mentioned above, for example, would recognize a percentage of revenue and expenses proportionately as the project was completed. In this case, the accrual method would show the prospective lender a more complete picture of the company’s revenue channel.
1Program, course, and extended classroom availability vary by location. In site-based programs, students will be required to take a substantial amount of coursework online to complete their program.
2Credits and degrees earned from this institution do not automatically qualify the holder to participate in professional licensing exams to practice certain professions. Persons interested in practicing a regulated profession must contact the appropriate state regulatory agency for their field of interest. For instance, typically 150 credit hours or education are required to meet state regulatory agency education requirements for CPA licensure. Coursework may qualify for credit towards the State Board of Accountancy requirements. However, it is the student’s responsibility to contact the state board of accountancy for the jurisdiction in which they are applying to determine whether they have completed the appropriate credit hours and coursework to qualify to take the CPA exam. Employees of DeVry University and its Keller Graduate School of Management are not in a position to determine an individual’s eligibility to take the CPA exam or satisfy licensing.
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In New York, DeVry University operates as DeVry College of New York. DeVry University is accredited by The Higher Learning Commission (HLC), www.hlcommission.org. The University’s Keller Graduate School of Management is included in this accreditation. DeVry is certified to operate by the State Council of Higher Education for Virginia. Arlington Campus: 1400 Crystal Dr., Ste. 120, Arlington, VA 22202. DeVry University is authorized for operation as a postsecondary educational institution by the Tennessee Higher Education Commission, www.tn.gov/thec. Lisle Campus: 4225 Naperville Rd, Suite 400, Lisle, IL 60532. Unresolved complaints may be reported to the Illinois Board of Higher Education through the online compliant system https://complaints.ibhe.org/. View DeVry University’s complaint process https://www.devry.edu/compliance/student-complaint-procedure.html Program availability varies by location. In site-based programs, students will be required to take a substantial amount of coursework online to complete their program.
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