Accrual accounting recognizes the revenue earned at the time of sale and expenses incurred by the company. Its examples include sales of the goods on credit, where sales will be recorded in the books of account on the date of sale irrespective of whether it is on credit or cash.
The most common examples of accrual accountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more are given below –
Let us discuss each one of them in detail with journal entries.
You are free to use this image on your website, templates, etc, Please provide us with an attribution link
Article Link to be HyperlinkedFor eg:
Source: Accrual Accounting Examples (wallstreetmojo.com)
- Accrual accounting is a method of accounting where accountants record revenue and/or expenses when a transaction occurs or when a payment is made.
- The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and other such things.
- Accountants use accrual accounting to give a clear picture by showing the real-time happenings of the business. It also helps investors make decisions and judgments about the business’s present and future.
In the accrual method, the transaction is recorded in the books of accounts when generating sales invoices, regardless of whether cash is received.
For example, X Ltd. sells goods of $500 to Y Ltd.
In the books of X Ltd.:
In this accounting methodAccounting methods define the set of rules and procedure that an organization must adhere to while recording the business revenue and expenditure. Cash accounting and accrual accounting are the two significant accounting methods.read more, the purchase is recorded in the books at the time of receipt of material and invoice regardless of cash paid later.
In the above example, Y Ltd. recognizes purchase books in its books of account.
In the books of Y Ltd.:
Example #3 – Income Tax Expenses
Income tax expensesIncome tax is levied on the income earned by an entity in a financial year as per the norms prescribed in the income tax laws. It results in the outflow of cash as the liability of income tax is paid out through bank transfers to the income tax department.read more are booked based on revenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more generated in the financial year, regardless of the actual payment.
Journal entries are as below –
Example #4 – Rent Paid In Advance
XYZ Ltd. paid rent for the 1st Q (January 2019 to March 2019) in advance to ABC Ltd on December 31, 2018.
In this case, rent expenses belong for January 2019 to March 2019 but were paid on December 31, 2018. So therefore, it cannot recognize expenses in December 2018.
Journal entries are as below –
In the books of XYZ Ltd.:
Note: Prepaid rent will show in the assets side of a balance sheet as on December 31, 2018.
In the books of ABC Ltd.:
Note: Rent received in advance will show on the liability side of a balance sheet as on December 31, 2018.
Example #5 – Interest Received On FD
XXYZ Ltd invested $500 in FD @ 5% for 5 years on January 1, 2019. It will receive the total amount after maturity, i.e., after five years on December 31, 2023, but accrued interestAccrued Interest is the unsettled interest amount which is either earned by the company or which is payable by the company within the same accounting period.read more will be recognized every year.
Journal Entry of accrued interest is as below –
Note: Accrued Interest will show in the assets side of the balance sheet as on December 31, 2019.
Example #6 – Insurance Expenses
XYZ Ltd pays an insurance premiumInsurance Premium is the amount paid by any individual or a corporate entity to cover themself from uncertain events resulting in heavy economic and non-economic losses.read more of $800 annually from July 1, 2018, to June 30, 2019, on July 1, 2018.
In the above case, 50% insurance premium is for 2018 and 50% for 2019.
Journal entries are as below –
Note: Insurance premium exp of $400 will be charged in profit & loss a/c for the year ended December 31, 2018, and insurance premium paid in advance of $400 will be shown on the assets side of a balance sheet as of December 31, 2018.
Example #7 – Electricity Expenses
Electricity company provides electricity to its consumer regularly, and the consumer receives the bill after the end of the month. Therefore, a consumer-like entity has to make provisions accordingly at the end of the month.
Example #8 – Post Sales Discount
In regular practice, many companies give post-sales discounts to their dealers on a quarterly, half-yearly, or annual basis for achieving a target at the end of the scheme period. The company must make monthly provisions to match the sales vs. discount for giving the correct monthly financial statementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more.
Example #9 – Depreciation
Depreciation is also recorded by the accrual method because no cash outflow or inflow is involved in depreciation transactions. In addition, devaluation reduces the value of fixed assetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more over the period because of their use or wear and tear.
For example, XYZ Ltd. purchased machinery worth $4,000 on January 1, 2018, and its useful lifeUseful life is the estimated time period for which the asset is expected to be functional and can be put to use for the company’s core operations. It serves as an important input for calculating depreciation for assets which affects the profitability and carrying value of the assets.read more is 10 Years. In this case, XYZ Ltd. has to pass below depreciation journal entryDepreciation Journal Entry is the journal entry passed to record the reduction in the value of the fixed assets due to normal wear and tear, normal usage or technological changes, etc. where depreciation account will be debited and the respective fixed asset account will be credited. The main objective of a journal entry for depreciation expense is to abide by the matching principle.read more in its books of accounts.
The above entry value of the machinery will decrease by $400 at the end of the year.
Depreciation will be charged under profit & loss a/c, whereas machinery will be shown on the assets side of a balance sheet as of December 31, 2018, with the value of $3,600 ($4,000 – $400).
Example #10 – Audit Fees
In every organization, audit fees are paid after the completion of the year or after the audit period. Therefore, the entity has to provide audit fees in its books of accounts.
Note: Audit fees will be charged under profit & loss a/c of the year ended December 31, 2018.
Conclusion
The accrual method of accounting gives a fair and correct picture of the business. It shows what is precisely happening in the industry on a real-time basis. Expenses and revenue are booked in the year for which they are related and not at the time of cash inflow or outflow, which give the correct profit & loss for the year. The accrual method of accounting helps investors to make decisions. Medium and large organizations use the accrual method of accounting. Small organizations do not use the accrual method because of its complexity and cost.
More workforce is required in the accrual method than in the cash method. Therefore, it also involves a cost.
Frequently Asked Questions
What are the kinds of accrual accounting basis?
The accrual accounting basis has four different types: Accounts Receivables, Accounts Payable, Accrued Revenue, and Accrued Liabilities.
Which is better cash or accrual accounting?
Out of the two, accrual accounting is a golden accounting standard because it provides a precise analysis of the company’s fiscal state. Due to this, companies prefer less cash accounting in current times.
Are there any disadvantages to accrual accounting?
Yes, accrual accounting poses some difficulties such as deception of the company records because some businesses misuse this method to hide their weaknesses. However, accrual accounting is beneficial when done in the right manner.
Recommended Articles
This has been a guide to Accrual Accounting Examples. Here we discuss the top 10 most common accrual accounting examples and journal entries. You can learn more about Financing from the following articles –