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What is accrual accounting?
Accrual accounting is a real-time accounting method that works on the basis that a company is likely to receive money for a product or service at some point. The company records the sale at the point of the transaction, even if the transaction was made using a credit card or deferred payment method.
With accrual accounting, transactions are recorded as they are agreed to instead of when they are completed. That way the company can record revenue or expenses even before the accounting period is over.
A business must use the accrual method of accounting if it has sales in excess of $5 million per year or gross receipts over $1 million per year.
This is in contrast with cash accounting, which only records a transaction at the point the company receives payment. Accrual accounting helps a business better plan its growth strategy, while cash accounting indicates current cash flow. Accrual accounting is considered a truer way of accounting because there is no delay between the income or expense and the exchange of cash.
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Accrual accounting example
Kara’s business used the equivalent of $1,142 in electricity for the month of August. Her electric company sends her the bill, which, under the accrual accounting system, Kara records in the books as a transaction taking place in August. Although she doesn’t actually pay the bill until September, the transaction is recorded as an expense for the month of August.