accrual accounting

Accrual accounting is a method that records revenues when earned and expenses when incurred, regardless of when cash changes hands.

Under accrual accounting, a company that delivers goods in December records the revenue in December — even if the customer doesn’t pay until January. Likewise, an expense incurred in March hits the books in March, whether or not the check has cleared. This approach matches economic activity to the period it occurs in, giving a more accurate picture of an entity’s financial position than the alternative.

That alternative is cash-basis accounting, which records transactions only when cash moves. Cash-basis is simpler, but it can distort results: a business could look profitable in a month it collected old debts while actually losing money on current operations. Because accrual accounting avoids this distortion, both GAAP and IFRS require it for most reporting entities [citation needed].

The gap between the accrual perspective and the cash perspective is precisely what makes the cash flow statement necessary. The income statement shows what happened economically; the cash flow statement reconciles that with what happened in the bank account.