Definition
Under the accrual basis of accounting, revenue is recorded when it is earned and expenses when they are incurred, regardless of when cash is received or paid. Financial statements under IFRS and US GAAP are prepared on this basis, because it matches income with the costs of earning it in the same period.
How it works
Cash basis is simpler: record income when money arrives and costs when money leaves. It works for very small businesses but distorts results whenever customers pay late, suppliers give credit or costs are paid in advance. Accrual accounting fixes that with receivables, payables, prepayments and accruals.
The price is more judgement: estimating unbilled costs, deciding when a service is delivered, assessing bad debts. Adjusting entries at each period end put those estimates into the books.
Because profit and cash diverge under accruals, always read the income statement together with the cash flow statement. The cash conversion cycle calculator shows how long profit takes to turn into cash.
Example: accrual vs cash basis
A consultancy delivers a 10,000 project in December and is paid in February. It also pays a 1,200 annual software subscription in December for the following year.
| Item | Cash basis: December | Accrual basis: December |
|---|---|---|
| Project revenue | 0 | 10,000 |
| Software subscription | (1,200) | 0 (prepayment) |
| Result | (1,200) | 10,000 |