Definition
Accrual accounting recognizes revenue when earned (not when cash is received) and expenses when incurred (not when paid). This matching principle provides a more accurate picture of economic activity than cash-basis accounting but creates timing differences between reported earnings and actual cash flows. Understanding these differences is essential for earnings quality analysis.
lightbulb Example
A SaaS company signs a $120K annual contract in December but recognizes only $10K revenue in December (1/12 of the contract). Cash basis would record the full $120K when payment is received. Accrual basis better matches revenue to the service period.
verified_user Key Points
- Revenue recognized when earned, not when received
- Expenses recognized when incurred, not when paid
- Matching principle improves accuracy
- Creates timing differences between earnings and cash