Accrual Concept – Meaning of Accrual Concept with Examples

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Accrual Concept – Accrual means recognition of revenue and costs as they are earned or incurred and not as money is received or paid. Expenses accrue when benefit is received and income is accrued when benefit is given.

Accrual Concept in Detailed – 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.

Accrual Concept

Accrual of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. Wikipedia

To understand accrual assumption knowledge of revenues and expenses is required. Revenue is the gross in ow 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 yeilding 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 for Rs.  60,000. Customers paid him Rs. 50,000 cash and assure him to pay Rs. 10,000 shortly. His revenue is Rs. 60,000. It arose in the ordinary course of cloth business; Mr. X received Rs. 50,000 in cash and Rs. 10,000 by way of receivables.

Examples

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.

Lastly, (3) Mr. A invested Rs 1,00,000 in a business. He purchased a machine paying Rs 1,00,000. He hired it out for Rs 20,000 annually to Mr. B. Rs 20,000 is the revenue of Mr. A; it arose from the use by others of the enterprise’s resources.

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 frst 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 instance Rs 16,00,000 are the expenses. Also whenever any asset is used it has a fnite life to generate beneft. Suppose, the machine purchased by Mr. A in the third example will last for 10 years only. Then Rs 10,000 is the expense every year relating to the cost of machinery. For the time being, ignore the idea of accounting period.

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 is Rs 60,000, not Rs 50,000 cash received. Expense (i.e., cost incurred for the revenue) is Rs 50,000, not Rs 20,000 cash paid. So the accrual concept based proft is Rs 10,000 (Revenue – Expenses).

As per Accrual Concept : Revenue – Expenses = Proft

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

In Simple Words

The meaning of accrual is something that becomes due especially an amount of money that is yet to be paid or received at the end of the accounting period. It means that revenues are recognised when they become receivable. Though cash is received or not received and the expenses are recognised when they become payable though cash is paid or not paid. Both transactions will be recorded in the accounting period to which they relate. Therefore, the accrual concept makes a distinction between the accrual receipt of cash and the right to receive cash as regards revenue and actual payment of cash and obligation to pay cash as regards expenses.

The accrual concept under accounting assumes that revenue is realised at the time of sale of goods or services irrespective of the fact when the cash is received. For example, a firm sells goods for Rs 55000 on 25th March 2005 and the payment is not received until 10th April 2005, the amount is due and payable to the firm on the date of sale i.e. 25th March 2005. It must be included in the revenue for the year ending 31st March 2005. Similarly, expenses are recognised at the time services provided, irrespective of the fact when actual payment for these services are made. For example, if the firm received goods costing Rs.20000 on 29th March 2005 but the payment is made on 2nd April 2005 the accrual concept requires that expenses must be recorded for the year ending 31st March 2005 although no payment has been made until 31st March 2005 though the service has been received and the person to whom the payment should have been made is shown as creditor.

In brief, accrual concept requires that revenue is recognised when realised and expenses are recognised when they become due and payable without regard to the time of cash receipt or cash payment.

Significance

  • It helps in knowing actual expenses and actual income during a particular time period.
  • It helps in calculating the net profit of the business

Intex Questions

Fill in the blanks with suitable word/words :

  • (i) Accrual concept relates to the determination of ……………….
  • (ii) Goods of Rs.50000 are sold on 25th March 2006 but payment is received on 10th April 2006. It will be a revenue for the year ending ………………..
  • (iii) Accrual concept requires revenue is recognised when ………………. and expenses are recognised when they become ……………….

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