Accrual accounting is very flexible, and as a result it is open to manipulation. However, accounting principles restrict this flexibility so that the financial statements reflect the economic reality. (Large firms have their financial statements audited by an external auditor for increased assurance that the accounting principles have been applied correctly.)
Two Main Accrual Accounting Principles
There are two main accounting principles: the revenue recognition rule determines in which period incoming cash flows need to be recognized as revenue and the matching principle tells in which period an outgoing cash flow needs to be expensed.
The revenue recognition principle states that revenues are earned in the period where the product is delivered or the service has been rendered, regardless in which period the customer pays the firm.
The matching principle states that cash outflows should be booked as an expense in the period where they help to generate revenue.
Accrual Accounting Principles Explained
– accrual accounting is very flexible; accounting principles limit this flexibility so that opportunities to cook the books are restricted, and, (ideally) the financial statements represent the economic reality
– the revenue recognition principle states that revenue is earned in the period when the products are delivered or services rendered
– the matching principle states that expenses need to be booked (‘matched’) in the period where they help to generate revenue