What is meant by accrual basis accounting?

Accrual basis accounting is a fundamental principle in accounting that states revenues and expenses should be recognized when they are incurred, not necessarily when cash is exchanged. This means that revenue is recorded when a service is performed or goods are delivered, irrespective of when payment is actually received. Similarly, expenses are recognized when they are incurred, rather than when they are paid. This approach provides a more accurate financial picture of a company’s performance and financial position during a specific period, allowing stakeholders to understand how the company is functioning beyond just cash flow.

By utilizing accrual basis accounting, businesses can align their revenues with the corresponding expenses, adhering to the matching principle, which enhances the reliability of financial statements. This way, a business can reflect its commercial activity in a given period, ensuring that revenue generated from operations aligns with the expenses incurred to generate that revenue, thus leading to a clearer understanding of profitability.