Accrual Accounting Made Simple

This approach is particularly important for growing enterprises that require precise financial insights to make more informed decisions.

What is Accrual Accounting?

Simply put, the accrual basis for accounting recognises revenue when it is earned, and expenses when they are incurred.

Recording financial transactions when they occur—irrespective of when the cash actually changes hands—allows businesses to account for any future obligations along with expected income. As a result, this presents a more realistic representation of the business’s current financial position.

For example, Sydney Solutions might provide services to clients throughout the month, but only issue invoices at the end of the period. Using the accrual basis of accounting, the company would record the revenue when the invoice is issued and match it with the expenses incurred to provide the services to the client—even if payment has not yet been received by the client. This ensures the financial statements reflect the company’s actual economic activities, rather than just the timing of cash movements.

In Australia, some small businesses may find cash accounting beneficial; however many other businesses must use accrual accounting to comply with the reporting requirements of the Australian Tax Office (ATO)(opens in new tab) and Australian Accounting Standards Board (AASB)(opens in new tab). Accrual basis accounting is widely regarded as best practice for businesses that manage inventory, offer sales on credit or have complex financial operations.

Accrual accounting journal entries are particularly advantageous for businesses that:

• Have complex financial setups or large transactions
• Seek to produce financial statements for stakeholders like investors or lenders
• Manage and maintain physical inventories
• Work under long-term contracts
• Operate on credit by purchasing goods or services and paying for them at a later date
• Want to capitalise on certain tax benefits

Types of Accrual Accounting

The accrual basis for accounting is underpinned by two key principles: the matching principle and the revenue recognition principle.

Both principles stand to ensure that financial statements provide an accurate and consistent representation of a business’s financial position, regardless of when the cash transactions occur.

Matching Principle

The matching principle dictates that expenses should be recognised in the same period as the revenue they help to generate. By following this principle, profits and losses for a given period are more accurate and reflect the true financial standing of a company.

If a business incurs expenses in December for services provided in November, those costs should be recorded in November’s financials.

For example, a Melbourne-based construction company working on multi-year projects would allocate expenses like labour and materials to the periods in which they contributed to revenue—even if those expenses were paid for at a later date. By doing so, the financial statements align more closely with the economic realities of the company, in turn providing better insights for leaders to make informed decisions.

Revenue Recognition Principle

Under the accrual basis for accounting, a company recognises revenue when it has delivered goods or services to a client or customer—fulfilling its obligations under the relevant contract or agreement. The revenue is considered realisable when the business expects payment for the delivered goods or services to occur.

Once the revenue is both earned and realisable, it is then recorded onto the income statement. But it’s key to understand that this occurs even if the payment has not yet been received. An accounts receivable entry is also created to track the amount owed by the customer. In short, the revenue recognition principle states that revenue should be recognised when it is earned or realised—which is when a business performs the actions that entitle it to the revenue.

For example, an Australian software company enters into a $500,000 contract to deliver a custom application for a client. Payments are tied to specific milestones such as initiation, beta testing and final delivery, so using the revenue recognition principle, the business would allocate revenue to each milestone as it is completed—ultimately providing a more accurate picture of the project’s financial performance.

Expense Recognition Principle

An expense is recognised when a company receives goods or services from a supplier or employee which obligates it to make a payment.

Just like revenue recognition, the key thing to note is that the expense is recorded on the income statement when incurred, even if the payment has not yet been made. An accounts payable entry is created to monitor the amount owed to the supplier or employee.

Accrual Accounting vs Cash Accounting

The choice between accrual and cash accounting methods significantly changes how a business tracks and reports its financial performance. Each method has its own pros and cons, so it’s important to read up on the differences between the two.

Cash Accounting

Cash accounting is a straightforward method in which income is recognised when payments are received, and expenses recorded when paid. This approach is often used by small businesses, freelancers or sole traders due to its simplicity and ease of use.

Advantages to cash accounting:

• Simplicity—it's easy to understand and implement, making it ideal for small businesses with limited resources
• Immediate tracking—you can quickly see the business’s cash position as there’s no need to account for future receivables or payables

Disadvantages to cash accounting:

• Limited accuracy—cash accounting doesn’t provide a complete picture of a company’s financial health. It could even show a profit during a period when the company is struggling with unpaid expenses
• Not suitable for larger organisations—the ATO requires businesses earning more than $10 million in turnover to use accrual accounting(opens in new tab).

Accrual Accounting

Accrual accounting records transactions when they are incurred, irrespective of when the cash changes hands. This method aligns income and expenses with the period in which they occur.

Advantages to accrual accounting:

• Accurate financial reporting—matching revenues with expenses, the accrual basis of accounting offers a detailed representation of a company’s profitability and operational performance
• More informed decision-making—businesses can make improved decisions based on accurate and timely financial data

Disadvantages to accrual accounting:

• Complexity—implementing and maintaining an accrual system can be more challenging and time-consuming than the cash method, because it tracks receivables and payables which occur in the future rather than cash which occurs now
• Cash flow data—because it doesn’t provide a direct indication of cash flow, this method may be misleading for cash-sensitive businesses

When to Use the Accrual Basis for Accounting

Here’s a few scenarios where accrual accounting is the preferred method:

For businesses with complex operations or large transactions

Companies that handle complex transactions or large volumes of business benefit from using the accrual accounting method. Recording financial activity in real-time is beneficial to businesses that also operate across multiple locations, manage a high volume of inventory or engage in long-term contracts, because this method allows businesses to account for sales, expenses, and liabilities as they are incurred, rather than waiting for the cash to flow through.

For businesses with investors or lenders

If a business is seeking investment or financing—or if it’s publicly traded—accrual accounting is nearly always required. Lenders and investors prefer this method because it provides a more detailed and accurate representation of the business’s performance. It highlights liabilities and receivables—offering a clear view of the organisation’s profitability and cash flow situation—an essential factor for key stakeholder decision-making.

Accrual accounting also enables more detailed reporting on long-term projects or sales contracts. For example, a company engaged in a large construction project can use accrual accounting to recognise revenue and expenses over the life of the contract, matching income with the associated construction costs as the project progresses. This method provides a better gauge of long-term financial health and profitability.

For businesses with inventory

Any business that maintains physical inventory—particularly manufacturers and wholesalers—will find accrual accounting greatly beneficial. Under this basis, inventory costs are accounted for when goods are sold, not when they are purchased—allowing the business to match its cost of goods sold (COGS) with the revenue generated from those items.

For example, a technology wholesaler may purchase devices from a supplier and hold them in inventory. The accrual method ensures that the associated costs of the goods are only recorded when the items are sold, matching the expense to the revenue it generates – once again painting a more detailed picture of the business’s financial position.

For businesses with long-term contracts

Accrual accounting is particularly useful for organisations involved in long-term contracts, such as those in the construction, manufacturing, software or services industries. These businesses often earn revenue over a long period of time but incur expenses and liabilities throughout the contract’s duration.

This method allows the organisation to recognise revenue and expenses in the period they occur, rather than waiting for the contract to end or when payments are made.

This upholds the revenue recognition principle which requires companies to record revenue when it is earned, not when payment is received.

For certain businesses, as required by law

In Australia, the ATO legally requires(opens in new tab) companies with a turnover exceeding $10 million to use accrual accounting. This is because this framework ensures consistency, transparency and accuracy in financial reporting—aligning with the legal and regulatory standards for large businesses and industries like finance, not-for-profit, and insurance. Public companies and certain private entities must also adopt the accrual basis to comply with specific industry and taxation requirements.

Accrual Accounting Journal Entries

Journal entries that follow the accrual basis of accounting help to ensure businesses maintain accurate financial records. These entries adhere to the double-entry accounting principle—where every financial transaction impacts at least two accounts: one debit and one credit.

For instance, consider a Perth-based consulting firm that provides services in June, but doesn’t receive payment until July. Using accrual accounting, the revenue is recorded in June. The journal entry would then debit the accounts receivable ledger and credit the service revenue ledger. Once the payment is received in July, a final entry would debit the cash ledger, and credit accounts receivable.

Prepaid expenses, such as annual insurance, are also recorded using accrual principles. If a Brisbane company pays $12,000 upfront for a yearly policy, an initial entry debits the prepaid insurance ledger and credits the cash. Each month, $1,000 would be recognised as an expense by debiting insurance expenses and crediting prepaid insurance.

The same goes for purchasing on credit. If a business purchases $200 worth of office supplies on a 30-day credit term, the accountant would debit the accounts payable ledger by $200, and credit $200 of office supplies, as seen below.

Accrual Accounting for Taxation Purposes

Accrual accounting not only has many benefits for reporting, but also for tax. This is once again based on the matching principle, which pairs revenue with related expenses in the same period—e.g. The 2024 tax year.

For taxation purposes, using the accrual basis of accounting adheres to the cornerstone of the entire method: income recognition. With this system in place, a business’s taxable income may potentially be higher in earlier periods compared to cash accounting, as it must report income as soon as it is earned, despite maybe not yet receiving cash payment. And on the expense side, organisations can deduct expenses in the year they are formed, which can also reduce the taxable income in the year the liability is incurred and potentially provide some financial relief.

One thing to note is that the timing differences between income recognition (accrual accounting) and the actual cash flow can raise a few challenges, especially for businesses that have delayed receivables or long-term contracts. To combat this, companies must manage their cash flow effectively and carefully to ensure they have sufficient cash to cover tax liabilities when they arrive, even if the cash from the receivables has not yet been received.

With the ATO again, requiring businesses with a turnover above $10 million to use the accrual accounting method, organisations should always report their income and expenses in a way that reflects their true economic reality as transparently and realistically as possible.

Transitioning to the Accrual Basis of Accounting

Switching over from a cash accounting method to an accrual basis is a common and significant step for Australian businesses, particularly as they begin to scale. The process involves updating financial systems, retraining employees and often consulting with qualified accountants to ensure compliance with the Australian Accounting Standards. While the initial transition does require effort, the benefits of improved financial accuracy and detail, which inform better decision-making, almost always outweigh the challenges.

The first step in the process is to review the existing financial records. Organisations need to identify transactions that were previously recorded on the cash basis, and then determine how to adjust them to adhere to the accrual method. For example, outstanding invoices or unpaid bills need to be recorded in the appropriate accounting periods back when they were incurred.

Next, businesses should implement robust accounting software designed to handle accrual accounting. Many opt to use a full-service tool like NetSuite, which offers features tailored to the local Australian tax laws and GST reporting. The software also includes unified order management, inventory, CRM and e-commerce to bring all the business operations under one roof – offering companies the solutions they need, as they scale.

Businesses with more complex financials should engage professional assistance from accountants or bookkeepers. These experts can ensure compliance with the AASB and help to prepare accurate and timely financial statements. During the first year of transition, companies should also conduct regular audits to verify the accuracy of their new records under the accrual basis, and identify and action any adjustments as needed.

Ultimately, making the switch to the accrual basis of accounting provides Australian businesses with a more precise financial overview of their organisation, enabling them to not only plan more strategically, but meet stakeholder expectations and make better informed decisions.

Make Accrual Accounting Easy with NetSuite’s Cloud-Based ERP

Running a successful business can be hard work, but staying compliant with accrual accounting doesn’t have to be. With NetSuite’s financial management solution, business leaders can use accrual accounting to quickly and accurately record transactions and stay on top of ATO regulations.

Learn more about how NetSuite can improve your business’s financial management.

Accrual Accounting FAQs

What is an example of accrual accounting?

Recording revenue when a service is provided, even if payment is yet to be received, is an example of the accrual basis of accounting.

What is the difference between cash accounting and accrual accounting?

Cash accounting records transactions when the cash is received or paid, while accrual accounting records transactions when they are earned or incurred – irrespective of when the payment is actually made.

What is accrual accounting in Australia?

In Australia, the accrual basis of accounting is the standard for businesses as it adheres to the Australian Accounting Standards Board (AASB) by providing a more accurate picture of financial performance and obligations.

Is an accrual a debit or credit?

An accrual can be a debit or a credit depending on whether it represents an expense (a debit) or a revenue (a credit) that has yet to be paid or received.

What is the accrual basis in accounting?

The accrual accounting method is a system that recognises and records revenues and expenses when they are earned or incurred, rather than when the cash actually changes hands.