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The Accrual Concept

Accrual concept applies equally to revenues and expenses. In accrual basis of accounting revenue is recognized when it is realized (refer to realization concept), that is, when sale is complete or services are rendered and it is immaterial whether the cash is received or not. Similarly, expenses are recognized in the accounting period in which they assist in earning the revenues, irrespective of the cash paid for them. Recognition of revenues and expenses for income determination, therefore, does not depend upon the time when cash is actually received for revenues or paid for expenses. The increases in cash may merely be offset by a decrease in some other asset. The essence of the accrual principle is that a mere promise on the part of a customer to pay money in future is considered revenue. Similarly, a promise on the part of the business entity to make payment in future can be considered as an expense. In addition, not all cash receipts are considered as revenues and not all payments in cash are considered expenses. Income (excess of revenue over expenses) is associated with the changes in owner’s equity and that it is not necessarily related to changes in cash. Example of each cash payments which are not expenses, included purchase of a machine for cash (an increase in one asset and machine and decrease in asset cash), the payment of creditors (a decrease in liability) and so on. “ It is thus clear that the accrual concept makes the distinction between the receipts of cash and the right to receive cash and the payment of cash and the legal obligation to pay cash, because in practice there is usually no coincidence in time between cash movements and legal obligations to which they relate.” The justification for the accrual concept is that earning of revenue and consumption of a resource (expenses) can be accurately related to specific time periods. The drawbacks include: (i) the apportion of expenses to different time periods is a time consuming process and (ii) financial statements become more complex for the layman who may find it difficult to understand the difference between the actual receipts of cash and the right to receive the cash and also the actual payments and the obligation to pay.

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