Two types of accounting methods exist for businesses -- cash and accrual. The accrual method is required under the Generally Accepted Accounting Principles (GAAP) and compared to the cash basis method, has a vastly different effect on the profits or losses of a business. Although businesses essentially operate in the same manner regardless of the accounting method used, the difference between methods lies within the manner in which income and expenses are recognized. Calculating accrual basis transactions for accounting is merely a process of applying the correct recognition rules.
1. Calculate all earned revenue. Earned revenue under the accrual basis is recognized when an invoice is sent to a customer for goods or services. Income is earned when services have been provided or goods have been sold to a customer. Income must be counted as earned even if payment for goods and services has not yet been received.
2. Calculate all incurred expenses. Expenses are incurred when services are purchased or utilized, and a bill is received from the vendor. Under the accrual method, expenses are recognized even if they are not yet paid.
3. Subtract accrued expenses from accrued income. The result is the net profit or loss under the accrual method. Due to the ebb and flow of work and business costs, the accrual method may yield higher profits or losses depending on the managerial planning of the company. For example, some businesses may plan to invoice or ship end-of-the-year product orders to customers the first week of January to reduce taxable income for the prior year. Similarly, a business may purposefully acquire additional costs at the end of the year to increase expense deductions.
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