The Importance of Accrual Accounting
To put it simply, accrual accounting is a concept that states transactions are recognised when they occur, not when money changes hands.
Now if that sounds like nothing more than gibberish to you, perhaps this example will help clear the dust. You sell a box of apples to John for £1,000. You give him an invoice, and allow him 30 days to pay it. However, tomorrow your tax return is due. You don’t want to include the £1,000 sale to John in it, because you haven’t even received the money yet! Unfortunately for you, the transaction is recognised when it occurs, not when the money changes hands. Therefore, since the sale has occurred, you include it and pay tax on the £1,000. On the surface this may seem like a big disadvantage, but this situation is actually good:- You have recognised your revenue instantly, which means income for the year will be higher and so will your profit. Things like this please the media, the shareholders, and anyone else who might have an interest in the company. If you had needed to wait until John physically paid you, it’d be another 30 days before you could show that £1,000 in revenue to stakeholders.
- At the time of the transaction you have also recorded a new asset. That asset would be a debtor, namely John as he owes you money, and therefore is recorded as an accounts receivable.
