What does accrual accounting recognize?

Accrual accounting recognizes revenues and expenses when they are incurred, regardless of when cash is exchanged. This method is grounded in the matching principle, which states that revenue should be recorded in the same period as the expenses incurred to earn that revenue, providing a more accurate representation of a company's financial position during a specific period.

For example, if a company delivers a product or provides a service in December but does not receive payment until January, under accrual accounting, the revenue from that sale is recognized in December. Similarly, if an expense is recorded when it is incurred, rather than when it is paid, it reflects the true cost associated with generating revenue during that period.

This approach contrasts with cash basis accounting, which only recognizes transactions when cash changes hands, thereby potentially providing a skewed view of a company's financial health if significant cash inflows or outflows occur in different periods. Thus, by recognizing revenues and expenses when they are incurred, accrual accounting provides a clearer and more consistent picture of a company’s financial performance.