accrual basis of reporting

The accrual basis of reporting is the rule that financial statements record revenues when they are earned and expenses when they are incurred, regardless of when the cash actually changes hands. It is the opposite of simply tracking your bank balance. If you do work in December but get paid in January, accrual reporting puts that revenue in December — when you earned it — not in January when the money arrived.

Why bother, instead of just watching the cash? Because cash timing can badly distort how a period really went. Suppose a consultant finishes a $10,000 project in December but the client pays in January, and she prepays $1,200 of next year's rent in December. On a cash basis, December looks terrible (money out, none in) and January looks great. On the accrual basis, December correctly shows the $10,000 of revenue she earned, and the rent is treated as a prepaid asset, expensed next year when the office is actually used. This matching of effort to results is the whole point.

Accrual reporting is required for general-purpose financial statements under both GAAP and IFRS because it gives a truer picture of performance than raw cash flow. The honest catch is twofold: accruals require estimates and judgment (how much will customers fail to pay? how fast does equipment wear out?), which opens room for error and manipulation; and accrual profit is not the same as cash, which is exactly why a separate cash flow statement exists alongside it.