What is the Accrual Principle?

What is the Accrual Principle?

The accrual principle, also known as the accrual concept, is a concept used in accounting that mandates the recording of accounting transactions in the actual period of occurrence, rather than the period of occurrence of related cash flows.

 The accrual principle is formally required by accounting frameworks across the globe, such as the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS). It is employed by most companies (except small-cap companies that employ cash basis accounting methods) in order to prepare financial statements.

How does the Accrual Principle Work?

According to the accrual principle, the performance and position of a company should be measured by recording economic events, regardless of the time of occurrence of actual cash flows. In simpler terms, accrual accounting only considers the time when the transaction takes place, rather than the time in which the actual cash payment is made or received.

Such an accounting methodology makes it possible to accumulate all information pertaining to revenue and expenses for a specified accounting period, without having to factor in the actual cash flows associated with the revenue and expenses during that accounting period.

 Thus, the accrual principle provides a remarkably accurate picture of a company’s present financial situation. However, the expenses associated with implementing such a complex method of accounting is relatively much higher compared to cash accounting methods. There are a few conditions that need to be satisfied in order to properly utilize the accrual principle. These are:

  • The revenue needs to be recorded at the time of invoicing the customer, not at the time of actual payment.
  • The expenses must be recorded at the time of incurrence, not at the time of actual payment.
  • An estimated amount of bad debt must be recorded at the time of invoicing the customer, and not at the time when a default by the customer seems imminent.
  • The depreciation of a fixed asset must be recorded over its useful life, and should not be charged to expense in the period of purchase.
  • Any commission to be paid to a salesperson must be recorded at the time when the salesperson earns it, and not at the time when the actual payment of the commission is processed.
  • Wages need to be recognized in the period when they are earned, and not in the period when they are paid.