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Accruals are adjustments for 1) revenues that have been earned but are not yet recorded in the accounts, and 2) EXPENSES that have been INCURRED but are not yet recorded in the accounts. The accruals need to be added via ADJUSTING entries so that the financial statements report these amounts.

An example of an accrual for revenue involves your electric utility company. The utility USED coal and many employees in December to generate electricity that customers received in December. However, the utility doesn't bill the electric customers for the December electricity until the meters are read in January. To have the proper amounts on the utility's financial statements, there needs to be an adjusting entry to INCREASE revenues that were earned in December and the receivables that the utility has a right to as of December 31.

Accruals are adjustments for 1) revenues that have been earned but are not yet recorded in the accounts, and 2) expenses that have been incurred but are not yet recorded in the accounts. The accruals need to be added via adjusting entries so that the financial statements report these amounts.

An example of an accrual for revenue involves your electric utility company. The utility used coal and many employees in December to generate electricity that customers received in December. However, the utility doesn't bill the electric customers for the December electricity until the meters are read in January. To have the proper amounts on the utility's financial statements, there needs to be an adjusting entry to increase revenues that were earned in December and the receivables that the utility has a right to as of December 31.

Under the accrual basis of accounting, revenues are reported on the income statement when they are earned. (Under the cash basis of accounting, revenues are reported on the income statement when the cash is received.) Under the accrual basis of accounting, expenses are matched with the related revenues and/or are reported when the expense occurs, not when the cash is paid. The result of accrual accounting is an income statement that better measures the PROFITABILITY of a company during a specific time period.

For example, if I begin an accounting service in December and provide $10,000 of accounting services in December, but don't receive any of the money from the CLIENTS until January, there will be a difference in the income statements for December and January under the accrual and cash bases of accounting. Under the accrual basis, my income statements will show $10,000 of revenues in December and none of those services will be reported as revenues in January. Under the cash basis, my December income statement will show no revenues. Instead, the December services will be reported as January revenues under the cash method. 

There will be a difference on the balance sheet, too. Under the accrual basis, the December balance sheet will report accounts receivable of $10,000 and the estimated true profit will be added to owner's equity or retained earnings. Under the cash basis, the $10,000 of accounts receivable will not be reported as an asset, and the true profit will not be included in owner's equity or retained earnings.

To illustrate a difference in expenses, we will assume that the heat and light expense that I used in my accounting service is metered by the utility on the last day of the month. The utilities that I used in December will appear on a bill that I receive in January and will PAY on February 1. Under the accrual basis of accounting, the utilities that I used in December will be estimated and will be reported as an expense and a liability on the December financial statements. Under the cash basis of accounting, the utilities used in December will be recorded as an expense on February 1, when the utility bills are paid.

For financial statements prepared in accordance with GENERALLY accepted accounting principles, the accrual method is required because of the MATCHING principle.

Under the accrual basis of accounting, revenues are reported on the income statement when they are earned. (Under the cash basis of accounting, revenues are reported on the income statement when the cash is received.) Under the accrual basis of accounting, expenses are matched with the related revenues and/or are reported when the expense occurs, not when the cash is paid. The result of accrual accounting is an income statement that better measures the profitability of a company during a specific time period.

For example, if I begin an accounting service in December and provide $10,000 of accounting services in December, but don't receive any of the money from the clients until January, there will be a difference in the income statements for December and January under the accrual and cash bases of accounting. Under the accrual basis, my income statements will show $10,000 of revenues in December and none of those services will be reported as revenues in January. Under the cash basis, my December income statement will show no revenues. Instead, the December services will be reported as January revenues under the cash method. 

There will be a difference on the balance sheet, too. Under the accrual basis, the December balance sheet will report accounts receivable of $10,000 and the estimated true profit will be added to owner's equity or retained earnings. Under the cash basis, the $10,000 of accounts receivable will not be reported as an asset, and the true profit will not be included in owner's equity or retained earnings.

To illustrate a difference in expenses, we will assume that the heat and light expense that I used in my accounting service is metered by the utility on the last day of the month. The utilities that I used in December will appear on a bill that I receive in January and will pay on February 1. Under the accrual basis of accounting, the utilities that I used in December will be estimated and will be reported as an expense and a liability on the December financial statements. Under the cash basis of accounting, the utilities used in December will be recorded as an expense on February 1, when the utility bills are paid.

For financial statements prepared in accordance with generally accepted accounting principles, the accrual method is required because of the matching principle.

Under the cash basis of accounting...

1. Revenues are reported on the income statement in the period in which the cash is RECEIVED from customers.
2. Expenses are reported on the income statement when the cash is paid out.

Under the accrual basis of accounting...

1. Revenues are reported on the income statement when they are earned—which often occurs before the cash is received from the customers.
2. Expenses are reported on the income statement in the period when they occur or when they expire—which is often in a period different from when the payment is made.

The accrual basis of accounting provides a BETTER PICTURE of a company's profits during an accounting period. The REASON is that the income statement prepared under the accrual basis will report all of the revenues actually earned during the period and all of the expenses incurred in order to earn the revenues.

The accrual basis of accounting also provides a better picture of a company's financial position at a moment or point in TIME. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported.

The accrual basis of accounting is required because of the matching principle.

Under the cash basis of accounting...

Under the accrual basis of accounting...

The accrual basis of accounting provides a better picture of a company's profits during an accounting period. The reason is that the income statement prepared under the accrual basis will report all of the revenues actually earned during the period and all of the expenses incurred in order to earn the revenues.

The accrual basis of accounting also provides a better picture of a company's financial position at a moment or point in time. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported.

The accrual basis of accounting is required because of the matching principle.