Accrual Basis Accounting

Accrual basis accounting is a system of accounting that matches revenues and expenses, respectively, to the period they were earned and incurred. Under accrual basis accounting, revenue is recorded when product is shipped or services provided. Similarly, accrual basis accounting requires expenses be recorded in the period in which the related revenues were recognized. Accrual basis accounting differs from cash basis accounting, where revenue and expense are recorded when cash is received or paid. Here's an example of accrual basis accounting: suppose a company sells and ships widgets to a customer for $500 in year 1. The customer pays $200 in year 1 and $300 in year 2. Under accrual basis accounting, the entire $500 would be reported as revenue in year 1, even though $300 wasn't received until year 2. Under accrual basis accounting, the company recognizes revenue when it has substantially fulfilled its obligations to the customer. Because accrual basis accounting requires allocating revenue and expense to different time periods, it is subject to both error and abuse. Nevertheless, only accrual basis accounting meets generally accepted accounting principles.