What is the Accrual Principle?

The accrual principle is the concept that you should record accounting transactions in the period in which they actually occur, rather than the period in which the cash flows related to them occur. The accrual principle is a fundamental requirement of all accounting frameworks, such as Generally Accepted Accounting Principles and International Financial Reporting Standards. When properly implemented, the accrual principle allows you to aggregate all revenue and expense information for an accounting period, without the distortions and delays caused by the cash flows arising from that accounting period.

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Examples of the Accrual Principle

Examples of the proper usage of the accrual principle are:

Record revenue when you invoice the customer, rather than when the customer pays you.
Record an expense when you incur it, rather than when you pay for it.
Record the estimated amount of bad debt when you invoice a customer, rather than when it becomes apparent that the customer will not pay you.
Record depreciation for a fixed asset over its useful life, rather than charging it to expense in the period purchased.
Record a commission in the period when the salesperson earns it, rather than the period in which he or she is paid it.
Record wages in the period earned, rather than in the period paid.

Accounting for Accruals

Recording transactions under the accrual principle may require the use of an accrual journal entry. An example of such an entry for a sale on credit is:

	Debit	Credit
Accounts receivable	8,000
Sales		8,000

In this entry, revenue is recorded before payment from the customer arrives, along with an accounts receivable asset in the same amount. In the following month, the customer pays the company, and the company records the following entry:

	Debit	Credit
Cash	8,000
Accounts Receivable		8,000

The cash balance increases as a result of the customer payment, which also eliminates the accounts receivable asset.

If you do not use the accrual principle, then you are using the cash method of accounting, where you record revenue when cash is received and expenses when they are paid. There are also modified versions of the cash method of accounting that allow for the limited use of accruals.

Disadvantages of the Accrual Principle

Though the accrual principle is widely followed, there are some disadvantages to using it. One is that some additional accounting skill is needed to understanding the concept. Without enough training, a bookkeeper could botch accrual entries, making the resulting financial statements less accurate. Another concern is that it can result in financial statements that are notably different from the underlying cash flows of a business; this is a particular concern when the use of accruals results in a reported profit, while net cash flows are negative. At an extreme, it is possible for an organization to run out of cash even while reporting profits.