accrual accounting
An accounting method that records revenues and expenses when they are earned or incurred, regardless of when cash is actually received or paid.
Example
“Under accrual accounting, the December sale was recorded in December even though the customer paid in January.”
Memory Tip
ACCRUAL accounting = record it when it's EARNED, not when cash changes hands.
Why It Matters
Accrual accounting gives you a more accurate picture of your true financial health than just looking at your bank balance. Understanding this method helps you make better decisions about spending, saving, and investments because it shows the complete financial reality rather than just the cash moving in and out today.
Common Misconception
Many people think that if they have not received cash yet, the money does not really exist or count as income. However, accrual accounting recognizes that you have earned revenue when you provide a service or sell a product, even if payment arrives weeks or months later.
In Practice
Suppose you are a freelancer who completes a 5000 dollar project in January but the client does not pay you until March. Under accrual accounting, you record that 5000 dollars as revenue in January when the work is done, not in March when the cash arrives. This means your January financial statements show the true profitability of your work, even though your bank account will not reflect the money for two more months.
Etymology
From Latin 'accrescere' (to grow, accumulate) — revenues and expenses ACCRUE (accumulate) when earned.
Common Misspellings
Small business accounting made simple
Related Terms
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See Also
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