Accrual vs. Cash

Accrual Basis vs. Cash Basis of Accounting

Tammy Brown

ACC290

August 6, 2012

Dorothy Welch

Accrual Basis vs. Cash Basis of Accounting

Accrual basis of accounting is a method of accounting in which each item is entered in the records as it is earned or incurred regardless of when actual payments are received or made. The accrual basis uses the revenue recognition principle, which requires that companies recognize revenue in the accounting period in which it is earned. The accrual method of accounting also uses the matching principle, which is the practice of expense recognition which dictates that expenses be matched with revenues. In order for revenues to be recorded in the period in which they are earned, and for expenses to be recognized in the period in which they are incurred, companies make adjusting entries. Adjusting entries ensure that the revenue recognition and matching principles are followed (Kimmel, Weygandt, & Kieso, 2010). Adjusting entries are required every time a company prepares financial statements. The company analyzes each account in the trial balance to determine whether it is complete and up to date for financial statement purposes. Every adjusting entry will include one income statement account and one balance sheet account. There are different types of adjusting entries such as deferrals and accruals, which are prepaid expenses and unearned revenues (deferrals) and accrued revenues and accrued expenses (accruals). Deferrals are costs or revenues that are recognized later than the point when cash was originally exchanged. Prepaid expenses are costs that expire either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies) (Kimmel, Weygandt, & Kieso, 2010). Revenues earned but not yet recorded at the statement date are accrued revenues. Accrued revenues may accumulate (accrue) with the passing of time, as in the case of interest revenue. An adjusting entry records the receivable that exists at the...