Question

Q2- What is the accrual basis of accounting? When should revenue and expense be recognized in the accrual basis? Provide an example.

Answer 1

Q2-

Accrual basis of accounting means transactions that are actually incurred or earned or happened are only recorded in the books of accounting.

Revenue are recorded in the books of accounts under accrual basis of accounting only when they are actually earned but not when received, if they are only received but not earned then such revenues are not recorded as revenue in books of accounts but recorded as unearned revenue.

Similarly, expenses are recorded in the books of accounts under accrual basis of accounting only when they are actually incurred but not when paid, if they are only paid but not incurred then such expenses are not recorded as expenses in books of accounts but recorded as prepaid expenses.

Revenues:

For example - When X Company sold goods $10,000 and also received $5,000 in advance for the goods to be sold in next month.

In this example, the goods actually sold are $10,000 so they are earned and they will be recorded in the books of accounts under accrual basis of accounting as Sales Revenue of $10,000 and goods to be sold in next month are not yet earned so Unearned Revenue of $5,000 is recorded as a liability.

Expenses:

For example - When Y Company has paid $15,000 in advance for the insurance of one year and it is also paid $8,000 salaries to its employees for current month.

In this example, the prepayment of $15,000 is not recorded as Insurance expense but recorded as Prepaid Insurance which is a current asset because the insurance expense is not yet incurred and it will be incurred when one year is passed whereas the payment of salaries to its employees is incurred so they will be recorded as Salaries expense of $8,000.