What it is:
How it works/Example:
Company XYZ must insure one of its buildings. The insurance company bills Company XYZ $600 every six months (one bill in January, the next in July). If each bill is for six months' coverage, then under the accrual method, Company XYZ would not record a $600 expense in January and a $600 expense in July (doing so would cash method); it would instead record a $100 expense each month for the whole year. That is, Company would match the expense to the periods in which it is incurred: $100 for January, $100 for February, $100 for March, and so on.Company XYZ was using the
As you can see, accruing recognizes economic events in certain periods regardless of when actual cash transactions occur.
Why it Matters:
Although it is more complex, harder to implement and harder to maintain than the cash method of , most analysts agree that accruing provides a more accurate picture of a company's performance. That's because in any given accounting period, revenues are associated with their corresponding expenses, which gives a truer picture of the real costs of producing the revenue in a given period.
Additionally, accruing allows companies to reflect the fact that sales may have been made and expenses incurred even if cash has not changed hands yet (as is often the case with sales made on credit and similar circumstances). This in turn produces financial statements that are comparable over time.
However, one of the big drawbacks of accruing is that it tends to obscure the nature of the company's actual cash position (e.g., a company may show millions in sales but only have $10 in its cash account because its customers haven't paid yet).