Advantages and disadvantages of accrual accounting

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Advantages and disadvantages of accrual accounting
Accrual accounting has both advantages and disadvantages. (Jupiterimages/BananaStock/Getty Images)

Accrual accounting is one of two financial reporting methods a business may use. The distinct feature of this method is that a company must record transactions as they occur. Companies can experience advantages and disadvantages with accrual accounting. In some cases, whether accrual accounting has disadvantages for the company is irrelevant, as generally accepted accounting principles requires it use for certain businesses.

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Better Income Measurement

The income statement offers better profitability measurement under accrual accounting. The company records transactions when they occur, thus giving a better historical record for income. Companies can also provide a better match for all revenues and expenses using accrual accounting. Business owners have a better view of net income because they can track exactly how much money the company spent to generate revenue.

More Accurate Balance Sheet

Balance sheet reporting is typically more accurate under accrual accounting. External stakeholders look to the balance sheet to calculate a company's economic wealth. This calculation depends on accurate asset and liability reporting. Companies can recognise a transaction instantly under accrual accounting. Purchasing a vehicle, for example, will result in an immediate increase to assets, even if the company still owes money on it. Increases to asset accounts provide a healthier balance sheet.

Inaccurate Cash Reporting

A significant disadvantage to accrual accounting is inaccurate cash balances. Because no cash must exchange hands during a transaction, a company may experience a higher than normal cash balance. This can mislead an owner into thinking more cash is available for business purposes. This also works in reverse under circumstances in which a company reports bills paid that artificially lowers the cash general ledger account. The general ledger account can report a negative balance even though the company has money in its bank account.

Requires More Work

Accrual accounting simply requires more work for accountants. They must match all revenue and expense transaction, post accruals for unpaid expenses and record deferrals for unearned revenue. These tasks require more thought and an increase in paperwork to trace transactions. Errors may also be more prevalent in accrual accounting. Accountants can make calculation errors that result in wrong amounts posted to the general ledger. A correcting entry is then necessary to correct the error.

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