The accrual basis accounting is one of the main underlying concepts that guide the preparation and presentation of financial statements. It facilitates proper matching and measurement of income and expenses.
Under the generally accepted accounting principles (GAAP) regarding accrual basis accounting, business firms recognize income the moment it is considered earned regardless of whether it has been paid or it still remains as a receivable.
On the other hand, the same accounting standard pertains to expense being recognized when incurred irrespective of whether it has been paid or is still a payable.
Accrual basis accounting simply states that business transactions are recognized when they occur and not when the fruits of it has been received or given.
In other words, income and revenues are merited when the work has been done or the product has been delivered while expenses are recognized the moment the entity accrue the benefits from the product/service.
The accrual basis accounting serves as the main basis and foundation in maintaining accounts such as payables, receivables, prepayments and accruals of expenses.
Payables – are financial obligations by the entity resulting from accruing expense. In layman’s term, payables are simply debts that the entity incurred. In financial statement presentations payables are recognized as liabilities.
Receivables – are financial instruments that the entity received from another entity as a result of service rendered or products delivered. It is the money which external businesses owe to the entity. The two-fold effects of accounting provide that receivables are recognized as current assets.
Prepayments – are payment in advance of the delivery of products or rendering of service. In reporting the financial statements of the entity, prepayments are considered as an asset.
Accruals – accruals can take the form of deferred tax liability and unearned revenues resulting from prepayments of customers. Moreover, accruals are recognized in the balance sheet as a liability.
The accrual basis accounting together with cash basis accounting are the two methods of recognizing income and expenses. Through the years, the issue of what method should be used in journal entries and financial statement preparations remain a disputable argument.
The conceptual framework of accountancy suggests that the accrual basis accounting should be used in recording transactions in journal entries to purport a more reliable figure on the financial position, performance and financial capacity of a business enterprise.
The International Accounting Standards Board (IASB) advises multi-national companies and businesses to used accrual basis accounting as opposed to cash basis accounting in recording business transactions because it is believed to be more accurate and relevant in reporting the business transactions of the entity.