The accruals concept is a fundamental principle of accounting that states that income and expenses should be recognized in the period in which they are earned or incurred, rather than in the period in which they are paid or received. The accruals concept is based on the idea that the financial statements should reflect the economic substance of transactions, rather than their legal form.
The accruals concept is applied through the use of accrual-based accounting, in which income and expenses are recognized based on the underlying economic events that give rise to them. This means that income is recognized when it is earned, and expenses are recognized when they are incurred, regardless of whether the cash has been received or paid.
The accruals concept is applied in a number of ways in accounting, including the recognition of revenue, the recognition of expenses, and the matching of revenue and expenses.
One example of the application of the accruals concept is the recognition of revenue. According to the accruals concept, revenue should be recognized in the period in which it is earned, rather than in the period in which it is received. This means that if a company performs a service or sells a product in one period, but does not receive payment until the next period, the revenue should be recognized in the first period, rather than the second period.
For example, if a company provides consulting services to a client in December and issues an invoice for £10,000, but does not receive payment until January, the company would recognize the £10,000 of revenue in December, rather than in January. This is because the revenue was earned in December, when the consulting services were provided, rather than in January, when the cash was received.
Another example of the application of the accruals concept is the recognition of expenses. According to the accruals concept, expenses should be recognized in the period in which they are incurred, rather than in the period in which they are paid. This means that if a company incurs an expense in one period, but does not pay the cash until the next period, the expense should be recognized in the first period, rather than the second period.
For example, if a company purchases office supplies in December for £500 and receives an invoice, but does not pay the cash until January, the company would recognize the £500 of expense in December, rather than in January. This is because the expense was incurred in December, when the office supplies were purchased, rather than in January, when the cash was paid.
