If money acts as the language of business, accounting serves as the journal. Business managers need money management skills to make the best decisions for the company. Accounting records the financial impact of the actions taken by the company and communicates the effect of those transactions. The accrual method of accounting presents the most accurate picture of the company’s financial health and relies on the accountant accruing certain transactions.
All publicly traded companies and any company with more than $5 million in sales are required to use the accrual method of accounting. The accrual method directs the company to record any transaction that occurs, whether or not cash changes hands during the same period. This method of reporting ties the actions with the time it occurs, rather than waiting for a payment to be received or sent.
Accrued expenses refer to items the company uses in one period and pays for in a future period. For example, a company that uses electricity during the month of May and receives the invoice in June does not pay for the electricity in the same month it uses it. The company receives the benefit of the electricity during May without expending any cash. Accrual accounting requires the company to record the value of the electricity used in May as an accrued expense.
Accrued revenues refer to occasions when the company earns revenue in one period but does not receive revenue until a future period. For example, a company that sells merchandise to a customer on credit in September and receives the payment in October does not record a payment at the time it delivers the merchandise. The company earns the income without receiving any cash. Accrual accounting requires the company to record the revenue from the sale in September as an accrued revenue.
Accruing expenses and revenues allows the company to recognize the activities that occurred during the same month the activities happened. Anyone reviewing the company’s financial statements see the activities of the company for that time frame. Accruing revenues and expenses also allows the company to match the revenues earned with the expenses used to earn that revenue. Accruing expenses and revenues presents a more accurate picture of the company’s profitability for the period.