Q.Test Your Understanding — Tick the correct answer:

1. Rahul's trial balance provide you the following information: Debtors ₹80,000; Bad debts ₹2,000; Provision for doubtful debts ₹4,000. It is desired to maintain a provision for bad debts of ₹1,000. State the amount to be debited/credited in profit and loss account:

Accrual Basis Accounting – A First Look

Think about a newspaper delivery. You pay for a month's subscription at the start. The newspaper company gets your money on 1st April, but it hasn't earned that money yet — it still has to deliver papers for the next 30 days. The company's profit for April isn't the cash it collected; it's the revenue from the papers actually delivered in April.

That's the core intuition behind accrual accounting: record income when it is earned, not when cash is received; record expenses when they are incurred, not when cash is paid.

The Precise Meaning

Under the accrual basis, transactions are recorded in the books of account at the time they occur, regardless of when the actual cash changes hands.

• Revenue is recognised when the goods are sold or services are rendered — even if the customer will pay later.
• Expenses are recognised when the benefit is consumed or the liability arises — even if the payment will be made later.

This is the opposite of cash basis accounting, where you record only when cash is received or paid.

Why It Matters

Accrual accounting gives a true and fair view of the business's financial performance and position.

• Matching Principle: Expenses are matched with the revenues they help generate in the same period. If you sell goods in March but receive payment in April, the sale belongs to March's profit calculation, not April's.
• Realistic Profit: Profit under accrual basis reflects the actual economic activity of the period, not just the timing of cash flows.
• Better Decision-Making: Owners, investors, and creditors see what the business has earned and owes, not just what it has in the bank.

Accounting Treatment – The Journal Entries

Accrual accounting gives rise to two special types of accounts: Outstanding Expenses and Accrued Incomes (also called Prepaid Expenses and Unearned Incomes on the other side).

1. Outstanding Expenses (Expense incurred but not yet paid)

Example: Salary for March is ₹50,000, but it will be paid in April.

Journal Entry (at the end of March):

• Debit: Salary A/c (expense is recorded in the period it belongs to)
• Credit: Outstanding Salary A/c (a liability — the business owes this money)

When paid in April:

2. Accrued Income (Income earned but not yet received)

Example: Commission earned ₹20,000 in March, but will be received in April.

Journal Entry (at the end of March):

• Debit: Accrued Commission A/c (an asset — the business is owed this money)
• Credit: Commission Income A/c (revenue is recorded in the period it was earned)

When received in April:

3. Prepaid Expenses (Expense paid in advance)

Example: Insurance premium of ₹12,000 paid on 1st January for the full year.

Journal Entry (at the end of the accounting year, say 31st March):

Only 3 months' insurance (Jan–Mar) has been used. The remaining 9 months' worth (₹9,000) is still an asset.

• Debit: Prepaid Insurance A/c (asset)
• Credit: Insurance A/c (reduces the expense to only the consumed portion)

4. Unearned Income (Income received in advance)

Example: Rent received ₹30,000 on 1st March for three months (March, April, May).

Journal Entry (at the end of March):

Only one month's rent (₹10,000) has been earned. The remaining ₹20,000 is a liability. …