Accrual Principle
The accrual principle, also known as the accrual basis of accounting or accrual accounting, is a fundamental concept in accounting that requires revenues to be recognized when they are earned and expenses to be recognized when they are incurred, regardless of when cash is received or paid. The accrual principle is the foundation of the matching principle, which dictates that revenues and expenses should be matched in the same accounting period to provide an accurate reflection of a company’s financial performance.
The accrual principle is essential for preparing financial statements that present a true and fair view of a company’s financial position and performance. It contrasts with the cash basis of accounting, which records transactions only when cash is received or paid, and may not accurately represent the company’s financial activities during a specific period.
In summary, the accrual principle ensures that:
- Revenues are recognized when they are earned, not when cash is received.
- Expenses are recognized when they are incurred, not when cash is paid.
The accrual principle is the standard accounting method for most businesses and is required under Generally Accepted Accounting Principles (GAAP) in the United States and the International Financial Reporting Standards (IFRS) globally.
Example of an Accrual Principle
Let’s consider a hypothetical example to illustrate the accrual principle in action.
Imagine a company called “Blue Ocean Consulting” provides marketing services to its clients. On September 10, Blue Ocean signs an agreement with a client for a marketing campaign worth $6,000. The campaign will run from September 15 to October 14, and the client agrees to pay the full amount on October 20.
Here’s how Blue Ocean Consulting would record the transactions using the accrual principle:
- Revenue recognition: Blue Ocean Consulting provides marketing services from September 15 to September 30 (the end of the month). According to the accrual principle, the company should recognize a portion of the $6,000 fee as revenue for September, even though it hasn’t received the payment yet. Assuming equal revenue recognition for both months, the revenue for September would be $6,000 / 2 = $3,000. The journal entry would be:Debit: Accounts Receivable (Asset) – $3,000 Credit: Marketing Services Revenue – $3,000
- Expense recognition: Suppose Blue Ocean Consulting incurs $1,200 in expenses related to the marketing campaign in September, such as employee wages, advertising costs, and software subscriptions. According to the accrual principle, the company would record these expenses in September when they are incurred, even if they haven’t been paid in cash yet. The journal entry would be:Debit: Marketing Services Expenses – $1,200 Credit: Accounts Payable (Liability) – $1,200
By applying the accrual principle, Blue Ocean Consulting’s financial statements for September accurately reflect the economic activity related to the marketing campaign. The revenue of $3,000 is recognized when it is earned, and the expenses of $1,200 are recognized when they are incurred, providing a more accurate representation of the company’s financial performance during the period.
