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.
The accrual basis is mandatory under the Companies Act, 2013 for all companies, and it is the foundation of the Generally Accepted Accounting Principles (GAAP) followed in India.
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.
A common mistake: thinking profit equals cash in hand. Under accrual accounting, a business can show a healthy profit but have very little cash (if most sales are on credit), or show a loss but have plenty of cash (if it collected old debts while making few new sales).
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):
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|
| March 31 | Salary A/c Dr. | | 50,000 | |
| To Outstanding Salary A/c | | | 50,000 |
| (Being salary for March due but not paid) | | | |
- 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:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|
| April 10 | Outstanding Salary A/c Dr. | | 50,000 | |
| To Cash/Bank A/c | | | 50,000 |
| (Being outstanding salary paid) | | | |
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):
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|
| March 31 | Accrued Commission A/c Dr. | | 20,000 | |
| To Commission Income A/c | | | 20,000 |
| (Being commission earned but not received) | | | |
- 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:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|
| April 15 | Cash/Bank A/c Dr. | | 20,000 | |
| To Accrued Commission A/c | | | 20,000 |
| (Being accrued commission received) | | | |
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.
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|
| March 31 | Prepaid Insurance A/c Dr. | | 9,000 | |
| To Insurance A/c | | | 9,000 |
| (Being insurance prepaid for the remaining period) | | | |
- 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.
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|
| March 31 | Rent Income A/c Dr. | | 20,000 | |
| To Unearned Rent A/c | | | 20,000 |
| (Being rent received in advance for April and May) | | | |
- Debit: Rent Income A/c (reduces the income to only the earned portion)
- Credit: Unearned Rent A/c (liability — the business owes the service)
Format in Financial Statements
These accrual adjustments appear in the Profit and Loss Account and the Balance Sheet.
Profit and Loss Account (extract)
| Particulars | Amount (₹) | Particulars | Amount (₹) |
|---|
| Expenses: | | Incomes: | |
| Salary (including outstanding) | 50,000 | Commission (including accrued) | 20,000 |
| Insurance (after deducting prepaid) | 3,000 | Rent (after deducting unearned) | 10,000 |
Balance Sheet (extract)
| Liabilities | Amount (₹) | Assets | Amount (₹) |
|---|
| Current Liabilities: | | Current Assets: | |
| Outstanding Salary | 50,000 | Accrued Commission | 20,000 |
| Unearned Rent | 20,000 | Prepaid Insurance | 9,000 |
A Formula That Appears in Practice
For calculating interest on capital (a common accrual adjustment in partnership accounts):
Interest on Capital = Capital × Rate of Interest × (Period / 12)
For example, if a partner's capital is ₹2,00,000 and interest is allowed at 10% per annum for 6 months:
Interest = 2,00,000 × 10/100 × 6/12 = ₹10,000
This interest is an expense for the firm (debited to Profit and Loss Appropriation A/c) and income for the partner (credited to the partner's Capital/Current A/c), even if no cash changes hands — a perfect example of accrual accounting in action.
The Big Picture
Accrual basis is not just a rule — it is the language that tells the true story of a business. Cash is just one character in that story. The real plot is about when value is created, when obligations arise, and when economic benefits are actually earned or consumed. Every journal entry you will learn in Class 12 — from depreciation to provision for doubtful debts — is built on this foundation.