Accrual Basis of Accounting

In accrual basis of accounting, changes in assets and liabilities resulting from earning process are recognized in the period when they occur rather than when they are paid.

The method of recording transactions by which revenues, costs, assets and liabilities are reflected in the accounts in the period in which they accrue. It includes considerations relating to deferrals, allocations, depreciation and amortizations. Accounting Standards (As) – 1 of the same institute explains the term accrual as: “Revenues and Costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the period to which they related. The accrual basis makes a distinction between actual receipt of cash and the right to receive cash and the actual payments of cash and the legal obligation to pay cash. “Revenue may be defined as the right to received cash and expenses as obligation to pay.” Thus revenue is realized when recognized and expenses are recognized when incurred. Thus a transaction is recorded at the time of its accrual and not till the actual flow of cash occurs, that is, items of income and expenditure are recorded at the time of their occurrence during the previous year. It means that the income accrued in the current year is recorded in the current year whether it is received during the current year or it was received in the previous year or it will be received in the next year. The same holds true for expenditure or expenses. It is recorded if it becomes due in the current year whether it is paid in the current year or it was paid in the previous year or it will be paid in the next year. The focus of the accrual basis of accounting is, therefore, on the realization of revenue, the incurrence of cost and matching of revenues realized with expired cost with the result that the profit calculated under the system is the profit actually earned during the previous year though not necessarily in cash. The accrual basis of accounting is also known as mercantile system of accounting.

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