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Accrual Accounting

Brian Krogol
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Alright. So now let's consider the differences between an accrual basis of accounting, which is what gap requires and a cash basis of accounting, which is generally just easier to use, but it doesn't follow gap. Okay, let's check it out. So first thing let's consider something. The only way for us to really know the worth of our company. For us to truly know the worth. We would have to liquidate the company right? And liquidate that. That means to sell all the assets, right? Any inventory we have, we just have to sell it off any machines we have for production, we sell them and just get all in cash. Right? So our only asset is cash and then we pay off all our liabilities, everybody that we owe money, the banks, our suppliers and then whatever's left over, right, Whatever's left over is the company's worth. Right. That's really the true way to know what the company's worth. But obviously an ongoing company just can't liquidate. Right? So what we do is we use these financial statements, they act as progress reports for the company. Let me use this thinner pen. And I think it reports, I think the thinner pen looks a little nicer. Okay, progress reports. Right? So the financial statements, they come out periodically. Right? And that's what this time period concept has to do with when we do accrual accounting, which is what gap requires. Well, in accrual accounting we're gonna we're gonna report our accounting information at regular intervals. Right? And these are gonna be consistent. So generally these are gonna be yearly, right? Or monthly or quarterly. Right? It's gotta be some sort of consistent interval. And in this interval we want to understand what happened during that interval right at the beginning we'll have about balance sheet at the beginning of the interval that tells us the assets liabilities equity, right that we have and then the income statements telling us what happened throughout the interval, say throughout the year. And then at the end of the year we'll have a new balance sheet showing the new position of the company. Right? So that's the time period concept that we're dealing with in accrual accounting. Right? But we're just breaking up the breaking up the time into these years but the time doesn't stop right it's just constantly going. So the reason we break it up is for the reporting process. So let's first think about accrual accounting And remember accrual accounting. This is gap. Okay. Gap requires a cruel accounting. So what does it mean? Well accrual accounting records the impact of business transactions as they occur. Okay so there's gonna be triggering events that make us make a journal entry or make some sort of record that this event occurred. Okay so with accrual accounting you're gonna see that every time there's some sort of event we're gonna make a journal entry. And let's think about revenue as well. So when we make a cash sale in accrual accounting. Well this was an event, right? We delivered our product, we did our job We're gonna make a journal entry, right? We're gonna make a journal entry. I'm gonna put J. E. For journal entry. And I'm also gonna put revenue right here because we do earn revenue at this point. Same thing with a credit sale right now this is what's gonna be different from a cash basis. So notice here in a cruel accounting when we make a credit sale this means that we give the customer the product but they didn't pay us yet. Right? We let them pay us. Later on we gave them say a month to pay. So when we make a credit sale in accrual accounting, we did our job. We gave the customer the product. We earned our revenue. Okay so we're gonna make a journal entry and we're going to earn revenue in this case. Okay now how about when we received the cash from that credit sale? Right. We made this sale let's say now a month ago. And now finally the customers paying us. Well now when the customer pays us this isn't a revenue entry, we took the revenue for this. When we gave the customer the product. Right now it's just a cash collection. This has not nothing to do with us earning the revenue. But we still make a journal entry. Okay this journal entry. It's going to be about accounts receivable. Right? We have some account receivable some money owed to us and we're collecting that account receivable. Right? So there's no revenue. There were just collecting an account receivable. How about when we pay our employees when we make a payment to our employees, we're gonna make a journal entry and generally this payment, well, it's going to get rid of the liability of the money we owe to the employees, right? There's money the employees work for us. And while they work for us, they're accumulating earnings right that we have to pay to them. So eventually when we pay them, this is us finally paying them and getting rid of that liability that we have right, we have this liability to pay these employees. So we're going to get rid of it, right? And this generally with with employment expenses, we're gonna get we're gonna get to this a little more and we'll deal with it in a little more detail. So you'll you'll see more details about that later. But just the idea that when they work for us, we're gonna get rid of this liability write of us owing them money when we finally pay them okay. And the last but not least. This is another trick with a Cruel County. So think about when an employee works, Let's say they had a pay day on January 28 and they kept working the next three days of the month, January 29, January 30, January 31. But we didn't pay them for those days yet. Right? So we have to accrue an expense for those days when we're doing accrual accounting, right? Let's say we're going to report our income statement on January 31. We last paid the employee on the 28th. Well he did work for us those three days on the 29th, the 30th and the 31st. But we didn't account for it in this period, right? Because our last payment to them was the 28th. We made a journal entry on the 28th but they kept working. So these three days we actually have to make a journal entry here and we're gonna learn more about these journal entries um to accrue this expense. Okay. For those three days, even though we didn't pay any cash, right? They worked for us those three days. The pay dates coming up someday in the future and we're gonna have to pay them on that future date. Right? But those three days that they worked this month, we have to accrue that expense this month. Okay. So we go into a lot more details about all of that uh throughout this unit. But I just want you to notice that all of these events are triggering for a journal entry. Right? We had to make a record in all of these cases. So let's go ahead and pause here and then we'll continue with the cash basis accounting and see how these same transactions are dealt with in the cash basis. Cool. Alright. So let's pause and we'll continue the rest of the sheet.