Accrual Basis of Accounting

One method which is available to accountants for keeping record of business transactions is called the Accrual Basis of Accounting. Accrual method of record-keeping means that the items are recorded in the books of accounts based on the Matching Principle.

Matching Principle means that an item which relates to the Year 2000, is recorded in the books of accounts related to that period. For example, if during the Year 2000 the company pays insurance premium for the coming year then although it will be recorded in the books but not exactly as an expense. Rather it is a prepaid expense, which relates to the coming year.

Hence, Accrual method means that any income which has been earned but which has perhaps not been collected, is recorded as an earning.

In the above shown entry of sales, the income comprises of two parts i.e. the cash part and the one which is based on credit. This part is still collectible and the company's books will continue to show Debtors worth 500 against this income.

But because the books are being maintained on Accrual basis, so the entire sales of 1,500 is recorded. In an alternative method of record-keeping the treatment will differ. That method is known as the Cash Based System of Accounting.

Rules for Journalizing Transactions

The basic operation of financial accounting within an organization starts from the journalizing of day-to-day transactions. Any business transaction no matter how inconsequential it may seem has to be properly recorded in the Journal.

As, I mentioned in the previous posts regarding classfication of elements, after having identified the respective class of the item, we only have to follow some basic rules. These rules are mentioned hereunder:

For Assets the rule is that if the asset is flowing towards the company (whose accounts we are maintaining), then the Asset account will be debited. And if the asset is disposed off in any way then the Asset account will be credited. These rules are the absolute rules of thumb for accounting. So, remember them always!

As I referred to previously Liability is treated oppositely to Assets. An increase in a Liability i.e. the company's payable increases, then the Liability account will be credited. And in case the liability is reduced by payment then the Liability account will be debited.

Likewise, the incurring of any expense will be debited and the earning of any revenue or income will be credited.

Capital is not absolutely but technically treated as a Liability which the company owes to the Owner of the business. So, the treatment is same as that for liabilities. When capital is introduced into the business then this increase is credited to the Owner's capital because this transaction results in the company owing more to the Owner. And debited when the Owner withdraws something out of the company for personal use.