If you’re involved in the finance field, you’ve likely heard of accrual accounting.But some people unfamiliar with the term might wonder what is accounting accrual and how does it impact businesses? Our team at Founder’s CPA will explore this topic and provide a breakdown of what you need to know. 

 

The definition of accrual accounting

Accrual accounting is a financial accounting method allowing companies to record revenue prior to receiving payment for the sold goods or services. As the expenses are incurred, they’re recorded. This means that the earned revenue and expenses that a business incurs are entered into their journal no matter when the money is received. 

Many times, accrual accounting is compared to cash basis of accounting; in this method revenue is recorded only when the goods and services are paid for. 

How it works

In terms of what is accounting accrual, the general concept is that entries are made when a good or service is provided versus when the payment is made or received. If there are debts or payments due, entries are also created.

It combines the current and future cash outflows and inflows to provide businesses with a more comprehensive and accurate picture of their existing and long-term finances. It follows the matching principle stating that revenues and expenses should be recorded within the same period. 

The International Financial Reporting Standard (IRFS) encourages this accounting method. Because of this, it has become the standard accounting practice for most companies outside of individuals and exceptionally small businesses.

How to qualify for accrual accounting

If a larger company has an average gross receipt of revenues over $25 million over the previous three years, they are required to use the accrual method for accounting.  In the case that a company doesn’t meet the average revenue requirement, they may choose to move forward with the cash basis or accrual accounting method.

For companies that carry inventory or make sales on credit, they are required to use accrual accounting regardless of what their size or revenue is. 

What are the benefits?

As we mentioned, this method provides a more accurate overview of the company’s condition. They will have instant feedback on what their expected cash outflows and inflows are which helps them oversee and manage their resources and create a plan for the future.  On the downside, it is relatively complex and expensive to implement. 

Accrual accounting vs. cash accounting

On the opposite end of the spectrum is cash accounting. With this method, transactions are only recognized when there’s a cash exchange. Cash basis and accrual accounting are also different in the way and time that transactions are entered.

Accrual accounting: Key takeaways

In this method, payments and expenses are credited or debited when incurred or earned. It uses double-entry accounting, meaning there are usually two accounts used for transactions. 

If you’re interested in learning more about this topic or you’re in need of accounting, tax and CFO services, Founder’s CPA is here to help. We’re located in West Loop, Chicago but we work with clients across the country. Get in touch to take advantage of our free 15-minute consultations! 

 

Curt Mastio
Post by Curt Mastio
Jun 7, 2024 9:09:11 AM
Curt Mastio started Founder’s CPA in 2017 and currently serves as the Managing Partner of the firm. After obtaining both his Bachelor’s and Master’s degrees in accounting from the University of Illinois in Urbana-Champaign Curt started his career in Big Four public accounting. Shortly thereafter Curt served as the Chief Financial Officer of Storage Squad began his stint as an Adjunct Instructor at Northwestern University’s Farley Center for Entrepreneurship and has been teaching Accounting & Finance to undergraduate students for 6+ years. In his current role Curt oversees strategy, operations, and business development at Founder’s CPA. Further, Curt has experience working directly with 200+ startups and small businesses providing accounting, tax, and outsourced CFO services. His industry expertise lies in the SaaS, Blockchain, Marketplace, and Fintech industries. He has served as a key advisor working directly with startups that range from pre-revenue to companies generating over $30 million dollars a year in revenue. Lastly, he serves a key role working directly with the firm’s clients that have collectively raised over $200 million in venture capital funding to date. Curt is also an active advisor, mentor, and investor in the startup ecosystem. He has facilitated numerous workshops, webinars, and presentations to incubators and other startup-centric organizations. He is also an active mentor for Techstars in both Chicago and Iowa. Outside of his daily professional duties Curt is actively involved with Beat the Streets Chicago and was a founding member of its Young Professionals Board. His efforts in both leadership and community involvement were recognized when he was awarded the Illinois CPA Society’s Outstanding Young Professional Leadership Award in 2020. He was also a panelist at their annual conference in 2022 where he spoke about his experiences starting and operating a public accounting firm. He maintains an active Certified Public Accountant designation that he obtained in 2014. Outside of work, Curt can be found spending time with his friends & family including his dog Rufus. His hobbies include golf, boating, cooking, reading, and attending sporting events & concerts.