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What is accrual method

what is accrual method

It's important for you to understand the basics of the two principal methods of keeping track of a business's income and expenses: cash method and accrual method (sometimes called cash basis and accrual basis). In a nutshell, these methods differ only in the timing of when sales and purchases are credited or debited to your accounts. If you use the cash method, income is counted when cash (or a check) is actually received, and expenses are counted when actually paid. But under the more common accrual method, transactions are counted when they happen, regardless of when the money is actually received or paid.

So with the accrual method, income is counted when the sale occurs, and expenses are counted when you receive goods or services. You don't have to wait until you see the money or until you actually pay money out of your checking account. With some transactions, it's not so easy to know when the sale or purchase has occurred. The key date here is the job completion date. Not until you finish a service or deliver all the goods a contract calls for can do you put the income down in your books. If a job is mostly completed but will take another 30 days to add the finishing touches, technically it doesn't go on your books until the 30 days pass.

Say you purchase a new laser printer on credit in May and pay $2,000 for it in July, two months later. Using the cash method of accounting, you would record a $2,000 payment for the month of July, the month when the money is actually paid. But under the accrual method, the $2,000 payment would be recorded in May, when you take the laser printer and become obligated to pay for it. Similarly, if your computer installation business finishes a job on November 30, 1999, and doesn't get paid until January 10, 2000, you'd record the payment in January 2000 if you use the cash method. Under the accrual method, the income would be recorded in your books in November 1999.

The most significant way your business is affected by the accounting method you choose involves the tax year in which income and particular expense items will be counted. For instance, if you incur expenses in the 1999 tax year but don't pay them until the 2000 tax year, you won't be able to claim them in 1999 if you use the cash method. But as you should now understand, you would be able to claim them if you use the accrual method, since the very essence of that system is to record transactions when they occur, not when money actually changes hands.

Category: Bank

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