Accrual basis of accounting recognizes revenues, expenses, gains and losses and the related increase or decrease in assets and liabilities in the period when the accounting event occurs. Both US GAAP and IFRS require that financial statements be prepared on the accrual basis of accounting.
Accrual accounting relies on the revenue recognition and the matching principles, which consider the timing of the recognition of business transactions and events.
Recognition is the process of formally recording a business transaction or event in an entity’s financial accounting records. Realization is the process of converting noncash resources and rights into money, which is achieved through the sale of an asset for cash or converting claims to cash. Whereas recognition is the act of recording a business transaction or event, realization establishes the completion of the earning process and is synonymous with cash inflow or outflow.
Recognition = Recording of a Transaction or Event
Realization = Cash Flow Due to a Transaction or Event
The cash basis of accounting considers the realization of – and the resulting cash flow from – a transition or event. Sole proprietorships, professional firms, such as accountancies and law firms, and small services companies normally use a cash-basis accounting system.
Accrual accounting relies on accounting recognition of transactions and event. The generally accepted accounting principles worldwide are based on the accrual basis of accounting and generally required for large firms, corporations and publicly traded companies.