What is 'accrual accounting'?

Accrual accounting is a foundational concept in accounting that recognizes revenues and expenses when they are earned or incurred, rather than when cash is actually received or paid. This method aligns with the principle of matching revenues to the expenses that were incurred to generate them, providing a clearer picture of a company's financial performance during a specific accounting period.

For instance, if a company delivers a service in December but doesn’t receive payment until January, accrual accounting mandates that the revenue from that service be recognized in December. Similarly, if expenses are incurred for a service in December that will be paid in January, those expenses will also be recorded in December. This ensures that the financial statements provide a more accurate representation of the company's activities and profitability by reflecting all economic events that occurred within the reporting period.

In contrast, other options presented do not accurately depict the principles of accrual accounting. The method involving only cash transactions focuses on cash flow rather than the broader timing of earnings and expenses, which is the hallmark of accrual accounting. Additionally, a focus solely on expenses does not encompass the revenue recognition aspect that accrual accounting involves. Finally, recording transactions solely at the end of a financial year ignores the ongoing nature of business transactions and the timely recognition of both revenues and expenses