accounting is necessary for many businesses due to the accounting
matching rule, which states:
- Revenues must be assigned in the same
period in which the related services were rendered or cost of goods
sold was expensed.
- Expenses must be assigned to the same period
that the expenses were used to produce revenues.
basis of accounting:
How accrual entries are made:
- Some businesses and individuals can use the
cash basis of accounting, where:
- Revenues are recognized when received
- Expenses are recognized when paid
- The cash basis of accounting does not work for
most businesses because:
- Taxing authorities do not allow it on tax
- The financial statements for any given period
are not as accurate, since events are not recorded as they occur.
examples of entries that would be used to record revenue that has been
earned, but not received at the end of the period:
- In order to put the revenue and expenses in the
proper periods, accrual entries need to be made.
- Accrual accounts such as accounts receivable
and accounts payable are used.
beginning of next period the payment is received from the customer:
(to recognize revenue earned but not
Here is an
expense accrual entry:
(to recognize payment received from
In the next
period the expense is paid:
(record expense not paid as of end of
(record payment for supplies)
By using accruals, the financial information reported is much more
accurate than using cash basis accounting. Care needs to be
taken by the Accountant to recognize all the economic events that
should be recorded in the current period.
Some other events that need to be accrued:
- Depreciation expense
- Prepaid rents
- Unearned revenues