Accrual Concept of Accounting

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Definition, Explanation and Application of Accrual Concept (Convention, Principle) of Accounting:

Accrual is derived from the verb “accrue” which means to increase, to accumulate or be added periodically. Accrual concept (convention, principle) of accounting defines and states that, “incomes when earned and expenses when incurred rather than when cash is received or paid. That’s why accountants record credit sales as income and credit purchases as expenses even though cash is not paid or received at the time of transaction”.

Example 1:

Let’s suppose a Ink company insure one of its buildings. The insurance company bills Ink company $600 every six months (one bill in January and the next in the month of July). If each bill is for six months of coverage, then under the accrual concept, Ink company would not record a $600 expense in January and a $600 expense in July (doing so would mean Ink company was using the cash method); it would instead record a $100 expense each month for the whole year. That is Ink company would match the expense to the period in which it was incurred; as, $100 for January, $100 for February, $100 for March, and so on.

Example 2:

Gerry purchases a plant for $100000, paying cash $60000 and sold it to John for $110000. Out of $110000, John paid only $70000. In this case, the revenue of Gerry is $110000 and not 70000. Expense is $100000 and not $60000. So, the profit earned will be $110000 (Revenue) – $100000 (Expenses) = $10000 (Profit).

Example 3:

Goods are sold to a customer in one accounting period but are not paid for until the next accounting period.

Solution:

The accrual and matching concept of accounting require the sale to be recognized in the accounting period in which the goods are passed to the customer, regardless of when payment takes place.