What Is Accrual Accounting?
Accrual accounting involves recording cash receipts and disbursements at the time of the transaction, not when the transaction is actually completed.
For example, if a government construction company uses accrual accounting, it records payments when the project is completed but may need approval from a government agency before payment is actually made.
On an accrual basis, contractors record contract revenue weeks or months before payments are actually received. If a public authority uses accrual accounting, it will record the payment at project close. Even if the check has not yet been sent.
Accrual accounting has its advantages and disadvantages, and it’s important to identify them in order to make the most of this powerful accounting method and protect your business from potential problems.
Advantages of Accrual Accounting
1. Compliance with GAAP
While you are not yet required to adopt accrual accounting, one of the strongest arguments for adopting this method for your business is that it is the method prescribed by GAAP.
If your business grows, you may have to move to accrual accounting in the future, so it will be very beneficial in the future to become familiar with this method.
2. More transparency
Accrual accounting is more transparent because, like cash accounting, it shows transactions not only when they have occurred, but also when they will occur.
This accounting method, therefore, provides management with a clearer picture of the company’s financial position at any given time.
3. Simplified strategic planning
Accrual accounting allows for better strategic planning because it reliably reflects future cash flows.
With this method, management can quickly determine when a cash shortage is likely or when a cash inflow is expected. As a result, this method allows for better planning to avoid crises due to unexpected shortages and to make the most of future profits.
The disadvantages of accrual accounting are
1. It can be complicated
Cash accounting is simple: expenses are recorded when incurred and revenues are recorded when realized. Accrual accounting, on the other hand, is not so simple. There are several rules and procedures for determining when and how to record certain types of expenses and revenues. In addition, completing tax forms can be a little more complicated if this accounting method is used.
Most of these rules and procedures are defined in generally accepted accounting principles. However, understanding them, implementing them, and applying them to your own business can be a challenge. With the help of a professional accountant. You can ensure that you are following the appropriate standards for your type of business, its size and its industry.
2. The transition to this accounting method can be difficult
Moving to accrual accounting can be difficult if your company is already using other accounting methods. For example, if there are cash flow problems, this may compound the problem. However, improved cash flow and transparency are important reasons for businesses to adopt this accounting method.
3. You may be more vulnerable to fraud
If you manage your company’s finances alone or with the help of a few back-office staff members. Accrual accounting can put your company at risk for fraud. To protect your business from internal fraud and to ensure the accuracy of your financial statements. You need to implement appropriate controls. This is especially important if you are unsure of your ability to analyze your company’s accounts and are unfamiliar with this type of accounting.
Tip: Outsourcing accounting is one of the easiest ways to thwart fraudsters. As it allows for a direct separation of accounting duties. The main good practice to prevent fraud is the usual accounting practice of segregation of duties!
Villie Walters Ramirez is a 32-year-old sales assistant at a Taxation firm who enjoys accounting and bookkeeping services. She has a post-graduate degree in accounting, and she has a severe phobia of cats. She enjoys traveling a lot.