Most businesses either use the cash basis of accounting or the accrual basis. While the cash basis of accounting is pretty clear cut, accrual accounting requires slightly more judgment. Cash accounting is characterized by recording transactions when cash is exchanged. Expenses are recorded and recognized when cash is paid for them. Sales or revenues are recognized when cash is collected.

For accrual accounting, expenses are recognized when they are owed and income is recorded when it is earned. While accrual accounting requires a little more thought, the results are a truer picture of the financial position of your company. It is a fundamental accounting practice that yields accurate results.

You can accrue income during your invoicing process. As you invoice, you would record the income and you would also increase accounts receivable. Then usually at month end, you would determine whether you have made sales but have not yet invoiced for them. At that point, you would record the sale and then increase accrued income. You should record accounts receivable only when you invoice for a sale.

Expenses also need to be accrued. Expenses should be recorded when you owe them. That means whether or not you have paid for the expenses or whether or not you have received an invoice for your expenses they need to be recorded. You would record the expense as well as the accounts payable for all of these transactions.

With accrual accounting not only are you recording transactions in their proper period, but you are matching expenses to the related revenues. Accountants have actually named that concept. Not surprisingly, it is called the matching principle. It is important to not only record transactions for the correct amount, but they also need to be recorded in the correct period or time frame. Results of operations become more predictable when they are not subject to the vicissitudes of the timing of cash based transactions. It also makes a lot of sense in reviewing the profit and loss statement when you can be assured that the expenses associated with earning revenue have all been recorded.

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