Accrual concept

  • Under accrual concept, the effects of transactions and other events are recognised on mercantile basis i.e., when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
  • Financial statements prepared on the accrual basis inform users not only of past events involving the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the future.

Revenue is the gross inflow of cash, receivables and other consideration arising in the course of the ordinary activities of an enterprise from sale of goods, from rendering services and from the use by others of enterprise’s resources yielding interest, royalties and dividends.

For example, (1) Mr. X started a cloth merchandising. He invested Rs.50,000, bought merchandise worth Rs.50,000. He sold such merchandise forRs.60,000. Customers paid him Rs. 50,000 cash and assure him to payRs. 10,000 shortly. His revenue isRs.60,000. It arose in the ordinary course of cloth business; Mr. X received Rs.50,000 in cash andRs. 10,000 by way of receivables.

Take another example; (2) an electricity supply undertaking supplies electricity spending Rs. 16,00,000 for fuel and wages and collects electricity bill in one month Rs.20,00,000 by way of electricity charges. This is also revenue which arose from rendering services.

Expense is a cost relating to the operations of an accounting period or to the revenue earned during the period or the benefits of which do not extend beyond that period.

In the first example, Mr. X spent Rs. 50,000 to buy the merchandise; it is the expense of generating revenue of Rs. 60,000. In the second instanceRs.16,00,000 are the expenses. Also whenever any asset is used it has a finite life to generate benefit. 

Accrual means recognition of revenue and costs as they are earned or incurred and not as money is received or paid. The accrual concept relates to measurement of income, identifying assets and liabilities.

Example: Mr. J D buys clothing of Rs.50,000 paying cash Rs.20,000 and sells at Rs. 60,000 of which customers paid only Rs.50,000.

His revenue isRs. 60,000, notRs. 50,000 cash received. Expense (i.e., cost incurred for the revenue) isRs.50,000, notRs.20,000 cash paid. So the accrual concept based profit isRs.10,000 (Revenue – Expenses).

As per Accrual Concept : Revenue – Expenses = Profit

Accrual Concept provides the foundation on which the structure of present day accounting has been developed.

Alternative as per Cash basis

Cash received in ordinary course of business – Cash paid in ordinary course of business = profit. Revenue may not be realised in cash. Cash may be received simultaneously or

(i)  before revenue is created (A. 1)

(ii)  after revenue is created (A. 2)

Expenses may not be paid in cash. Cash may be paid simultaneously or

(i) before expense is made (B. 1) (ii) after expense is made (B. 2)

A. 1 creates a liability when cash is received in advance.

A. 2 creates an asset called Trade receivables.

B.1 creates an asset called Trade Advance when cash is paid in advance while

B. 2 creates a liability called payables or Trade payables or outstanding liabilities.

If the expenses remain unpaid in respect of goods, it is called Trade payables, if it remains unpaid for other expenses, it is called Expense payables.

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