Businesses rely on their accounting staff to record financial transactions and to create accurate financial reports. Accounting requires the company to consider the activities of the business during the time frame reported. These activities include sales activities and operational activities performed in order to earn income during the period.
Companies choose between two different accounting methods. Cash-based accounting relies on the exchange of cash to determine when a financial transaction occurs. Accrual accounting records transactions based on the exchange of cash or the future obligation for an exchange of cash. In other words, as a business provides services or merchandise to its customers, it records a revenue whether it receives cash or the right to receive cash in the future. Many companies use accrual accounting because it provides a clear picture of the profit generation for the period.
Purpose Of Accruals
Accrual accounting requires the accounting staff to record accrual entries at the end of each accounting period. Since accrual accounting records transactions without the exchange of cash, some transactions are not recorded when the end of the period arrives. Accrual entries consider these transactions and record the entry in the financial records before the accounting staff creates the financial statements. This allows the financial statements to include all relevant transactions. Accountants record entries for two types of accruals, accrued revenues and accrued expenses.
Accrued revenues represent revenues earned but not yet received by the company. When companies provide services or products to customers in exchange for a promise to pay, the money earned represents an accrued revenue. If the company sends an invoice to the customer, it records the revenue at that time. If the company will not mail an invoice until the following period, the accounting staff records a manual accrual entry, increasing accounts receivable and increasing revenue for the amount of the transaction. The accounting staff reverses this entry after the next period begins.
Accrued expenses represent expenses incurred but not yet paid by the company. When companies receive invoices for services or products they received, the money owed represents an accrued expense. The company records the expense when it receives the invoice. If the company will not receive an invoice until the following period, the accounting staff records a manual accrual entry increasing accounts payable and increasing the expense for the amount of the transaction. The accounting staff reverses this entry after the next period begins.