There are two methods of recognizing expenses and income in accounting: accrual and cash basis. The kind of method your company chooses will determine how it records and tracks finances.
While the cash method is a simpler way of recording finances in the books, the accrual method allows businesses to recognize expenses and revenue as they’re incurred.
An accrued expense is therefore an incurred expenditure that hasn’t been paid. Such expenses are usually periodic and documented on a balance sheet because of the high likelihood that they’ll be collected. Here’s a list of reasons why you should accrue these expenses.
The accrual system is efficient for monitoring activities and financial management. With this system, your business receives an immediate reflection of the amount of money you have coming and what you can anticipate to see on future expenditure reports.
Furthermore, the methodology allows business analysts to look for financial trends and calculate current cash flow statements regularly, keeping everyone updated as possible.
Accruing allows for easy planning because it permits you to account for your revenue and expenses within the right period. Consequently, you’ll be able to develop budgets for your expenditures and predict sales, which is vital for staffing, inventories, and other areas of operation.
Besides planning, the accounting system can help reduce your tax burden by giving invoices at the beginning and end of the year. Furthermore, you can strategize ways of improving sales and generating more revenue since you don’t have to wait for money to be received in order to see your profits.
Accruing gives businesses a truer depiction of your financial responsibilities and resources. This is advantageous to your business because it allows for the proper management of financial activity. Therefore, you can assess your debts and income more accurately.
A small business may operate on a cash-based system for a while but once it expands, the business might need to reconsider its accounting system. You’ll discover that most businesses depend on credit in order to survive or expand, making the accrual method beneficial for a growing business.
In the U.S., GAAP is the industry standard for the preparation of financial statements. In fact, companies with $5 million dollars in yearly sales or $1 million dollars in yearly inventory sales are legally obligated to use the accrual system for revenue tax preparation and reporting their financial information. GAAP compliance also allows investors to access your business’s financial picture easily.
Reflects the true loss or profit of the business
Numerous businesses run on a monthly budget or report on a monthly basis. However, not every bill is invoiced similarly. For instance, in the event that utility bills are billed quarterly, the accrual system considers these costs irrespective of when an invoice is paid or received.
Applies Matching Concept
The accrual method makes it possible to apply the matching concept where companies identify revenues and their associated expense in the same accounting period. Therefore, companies report revenues together with the expenditures that generate them.
The goal of this concept is to prevent misstating revenues for a period. Bear in mind that reporting earnings for a period without reporting every expense that generated them could lead to overstated profits.
This method is more efficient for handling complex transactions since you’re tracking the cash in varied accounts depending on whether it’s obtained in advance or anticipated but not yet obtained. You are accounting for costs you’ve incurred but haven’t paid, enabling you to avoid overspending.
When implemented suitably, accrual accounting can be beneficial. Nevertheless, it’s important you understand the benefits, drawbacks, and discuss them with your accountant, so you can establish whether it’s best to apply it in your business.
Dailey Bookkeeping Services is a Xero Certified SILVER Partner and a QuickBooks Online Certified Advisor, so if we can help you with your accruing needs, just give us a call, we would love to help you! The owner, Jacqueline Dailey is a Certified Public Bookkeeper, an Advanced Certified QuickBooks and QuickBooks Online ProAdvisor, a Sleeter Group Certified QuickBooks Consultant and a Xero Certified Silver Partner. We work remotely so we can work with any company located in the U.S. If we can help you with this process or provide you with custom reporting, please give us a call. If we cannot help you, we will refer you to someone who can! Feel free to visit our website at http://www.