Accrual Basis of Accounting - Definition, Working, Advantages and Disadvantages

How Does Accrual Basis of Accounting Work?

The central idea of accrual basis of accounting is that financial transactions are recognized by matching revenue with expenses at the time of the transaction, not the payment.

By incorporating both current cash flow and future cash flows, this method offers a more accurate picture of a business's financial health.

The accrual basis was adopted in response to the growing complexity of financial transactions and the demand for a more precise understanding of a business's financial status.

Benefits of Using Accrual Basis of Accounting

Here are some noteworthy advantages of the accrual basis of accounting:

1. It provides a truer picture of a business's profit, thereby increasing reliability.

2. Businesses using accrual basis accounting are often perceived as more trustworthy than those using cash basis accounting.

3. Only when a business chooses accrual basis accounting can its financial statements be audited.

4. This method facilitates easier planning as it accounts for all revenues and expenses that will occur during the accounting period, enabling more accurate budgeting.

Drawbacks of Accrual Basis of Accounting

Despite its benefits, accrual basis of accounting has its downsides:

1. It can be complex and may require more skill, time, and resources to implement and maintain.

2. It can potentially misrepresent a company's short-term financial position.

With that, we wrap up our discussion on the accrual basis of accounting, a crucial topic for commerce students. Stay tuned for more interesting articles.