What is accrual accounting?

Accrual accounting is a financial accounting method where revenue and expenses are recognized when they are earned or incurred, regardless of when cash transactions occur. This approach aligns with the matching principle, which states that expenses should be matched with the revenues they help to generate within the same period. For example, if a service is provided in December but payment is received in January, under accrual accounting, the revenue would still be recorded in December when the service was rendered.

This method provides a more accurate picture of a company's financial position and performance over time because it includes all transactions that have an impact on the company's finances, not just those where cash changes hands. It permits businesses to record their obligations and resources in a way that reflects their actual financial activities, which is crucial for both internal decision-making and reporting to external stakeholders.

Each of the other methods stands in contrast to this explanation. Focusing only on cash transactions would omit significant revenue and expenses, leading to a distorted view of a company's financial health. Documenting only completed transactions ignores accrued revenues and expenses that have yet to be finalized in cash transactions. Finally, a budgeting approach for future cash flows does not pertain directly to the recognition of transactions within accounting periods, which is central to accrual accounting.