Accruals basis definition
The methodology behind accrual basis accounting is to make a record of revenues when they are earned – as opposed to recording them when the cash is actually received.
Likewise, when using this method of accounting, any business expenses need to be reported as they take place, rather than when they are actually paid.
The idea behind this is that, by recording transactions as soon as they occur and matching revenues earned to expenses incurred, it provides a more accurate and reliable overview of how the company is doing financially.
As an example of how this works practically, a company using the accruals basis method of accounting would record a transaction as soon as it sends an invoice to a customer. This is different to the cash basis method of accounting, under which the sale would only be recorded once the cash had been paid.
This accounting methodology is often used by large businesses and is also favoured by investors, because it is considered to be a more accurate reflection of a company’s incomings and outgoings over a period of time, while it also supports the matching principle (matching revenues to expenses within the same reporting period).
While it may be tempting (and seem simpler) to record transactions under cash basis accounting, accruals basis accounting actually makes more sense when you take into account things like steady revenue streams that may provide income over a period of time (rather than all at once) and selling or buying on credit.
For explanations of other common accounting terms, take a look at our glossary here