12.3: Accrual Accounting

Learning Objectives

1. Understand the difference between cash-basis and accrual accounting.
2. Understand the purpose of a statement of cash flows and describe its format.

In this section, we’re going to take a step further into the world of accounting by examining the principles of accrual accounting. In our Stress-Buster illustration, we’ve assumed that all your transactions have been made in cash: You paid cash for your inputs (plastic treasure chests and toys) and for your other expenses, and your customers paid cash when they bought Stress-Buster packs. In the real world, of course, things are rarely that simple. In the following cases, timing plays a role in making and receiving payments:

• Customers don’t always pay in cash; they often buy something and pay later. When this happens, the seller is owed money and has an account receivable (it will receive something later).
• Companies don’t generally pay cash for materials and other expenses—they often pay later. If this is the case, the buyer has an account payable (it will pay something later).
• Many companies manufacture or buy goods and hold them in inventory before selling them. Under these circumstances, they don’t report payment for the goods until they’ve been sold.
• Companies buy long-term assets (also called fixed assets), such as cars, buildings, and equipment, which they plan to use over an extended period (as a rule, for more than one year).