The Accrual Method for a Profit & Loss Statement
The profit and loss statement, or P&L, is a financial statement a company uses to report its profit -- the difference between its total income and total expense for the period. The accrual method is the most common accounting method a company uses to recognize, or record, its revenues and expenses to the P&L.
The accrual method records expenses and revenues when they are incurred and not when cash is transferred or when the physical invoices or statements are processed or issued. The accrual method may result in two entries in either order -- one entry to recognize the revenue or expense and the other to recognize the receipt or payment of cash.
The accrual method is an effective method of accounting when a company adheres to the matching principle and offsets its revenue with expenses. For example, if a company spends $200 on a job that earned $1,400, the accrual method matches, or offsets, the expenditure to the revenue it generated, resulting in a net profit of $1,200.
Assume that on Feb. 26 a company quotes a project to one of its vendors at a total job cost of $56,000. The company uses the accrual method of accounting. Although the work will not begin until March 8, the customer insists on paying for the project in advance.
The journal entry to record the cash receipt to the general ledger at the time of transaction using the accrual method will be as follows:
(DR) Cash 56,000 (CR) Unearned Revenue 56,000
Since the accrual method recognizes revenues when earned, the advance payment credits, CR, or increases unearned revenue, a liability account. It also debits, DR, or increases cash. The payment will not be recognized as revenue until the job has been completed on the project finish date of March 14.
On March 14, when the job has been carried out to completion, the company will record the following journal entry to remove the advance payment from the liability account and recognize the earned revenue as follows:
(DR) Unearned Revenue 56,000 (CR) Revenue 56,000
The profit and loss statement for the month of March, not February, will reflect the revenue earned on the completed job.