Definition
Accrual accounting is an integration of two key accounting principles: 1. the revenue recognition principle and2. the matching principle The revenue recognition principle mandates revenues to be recognized as they are earned or realized. As per the matching principle, expenses are to be recognized in the same period as the revenue that is generated from them. Accrual accounting helps in clearing the relationship between revenue and expense and offers a better insight into a company's profitability. This format of accounting allows companies to have a clearer picture of their asset and liability position as well. Therefore, accrual accounting is the only method permitted as per General Accepted Accounting Principles (GAAP). The Securities and Exchange Commission (SEC) also requires publicly traded companies to follow this principle for their accounting practices.
Example
Accrual accounting example:Suppose a company is using accrual accounting to maintain its accounts. Any revenue or income generated through sales and expenses that it incurs will be recorded as and when they occur.So, if the company sells products on credit, the sale gets recorded as per the invoice generated. There are chances that the company has not received the cash at that point in time.
Why it matters
Accrual accounting offers a more accurate picture of a company’s finances. Investors and stakeholders rely on this method to get a consistent view of the company's key performance metrics. Accrual accounting also makes companies GAAP compliant.Even if a company is a startup, it must move to accrual-based accounting to ensure easier external funding.