Accrual Concept

Definition: The accrual concept is one of three basic accounting concept, others are going concern and consistency. As per this concept, the recognition of the transactions and events as and when they arise, i.e. on mercantile basis, rather than on cash basis in which the transaction is recorded in the books of accounts when the cash is received/paid against it.

In business parlance, accrual implies the recognition of revenue and expenses as they are earned or incurred and not when they are received or paid. Revenue implies the overall cash inflow, receivables and other consideration, that arises out of regular business activities, from the sale of products or rendering of services. On the other hand, expenses connote the cost incurred in relation to the business operations in a particular financial year.

In business, it is not necessary that the instant payment is received or made against any transaction in cash. That is why the recognition of accrued revenues and expenses is done as they are earned or incurred and not when they are received or paid. So, it clarifies the difference between receipt of cash and the right to receive it, and disbursement of cash and obligation to disburse it.

In short, in accrual concept, the recording and reporting of the transactions in the financial statements is carried out in the accounting year to which they belong.

When a firm follows accrual concept, it helps the readers of the financial statement to get information about the past and future events, i.e. the transactions on which receipt is due or received and obligations that are paid or yet to be paid.

Adjustment entries concerning outstanding expenses, prepaid expenses, accrued income and income received in advance etc. are made on the basis of this concept, which affects the profit and loss account and balance sheet of the company.

Example

Alex purchases a machinery for Rs. 1,00,000, paying cash Rs. 60,000 and sold it to Joseph for Rs. 1,10,000. Out of Rs. 1,10,000, Joseph paid only Rs. 70,000. In this case, the revenue of Alex is Rs. 1,10,000 and not 70,000. Expense is Rs. 1,00,000 and not 60,000. So, the profit earned will be 1,10,000 (Revenue) – 1,00,000 (Expenses) = 10,000 (Profit).

Accrual concept is the foundation of the present accounting system, called as accrual system of accounting, as it helps in the measurement of income and expenses, and identification of assets and liabilities.