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Accrual Accounting

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DOI: 10.1007/978-3-319-31816-5_2271-1

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A
Accrual Accounting
Adriana Tiron-Tudor
Department of Accounting and Audit,
Babes-Bolyai University, Cluj-Napoca, Cluj,
Romania
Synonyms
Accrual basis of accounting; Accrual concept;
Accrual method; Accrual system
Definition
Accrual accounting is “a basis of accounting
according to which all the transactions and events
are recorded when they occur, without a relation
with cash inflow or outflow. Therefore, the oper-
ations and events are recorded in the accounting
records and recognized in the set of financial
statements of the periods to which they relate.
The elements recognized under accrual account-
ing are assets, liabilities, net assets/equity, reve-
nue, and expenses” (IPSASB 2006).
The Accounting Methods
The importance of the accounting information
presented in the financial statements for
decision-makers is very well known in practice
# Springer International Publishing AG 2017
A. Farazmand (ed.), Global Encyclopedia of Public Administration, Public Policy, and Governance,
DOI 10.1007/978-3-319-31816-5_2271-1
as well as in literature. The financial statements
represent the result of recording transactions in a
sequential and systematic manner following a set
of rules, prescribed in the accounting method.
Most entities typically use one of two basic
accounting methods to record transactions:
accrual or cash basis.
The term “accrual basis” refers to recording
expenses or revenues when they occur, regardless
of when cash is exchanged. Alternatively, the term
“cash basis” refers to any entry recording with a
cash impact. According to the accrual concept,
expenses occur when materials are consumed,
not when materials are acquired. Revenues are
recorded when the right to receive the money is
issued not when the money is received in cash or
by bank transfer. Opposite to this, the cash method
supposes a flow of money in and out of an entity,
so revenues are recorded when money is received,
and expenses, when it is paid.
Cash-basis statements are simple, readable, but
they can result in misleading financial statements.
Accrual basis is relative complex and more expen-
sive to implement, but looks at the economic
reality of the activities, rather than the actual
cash inflows and outflows.
“Accruals” and “cash” are often portrayed as
opposing end-points on a spectrum of possible
bases for accounting and budgeting. In practice,
other two hybrids approaches can be classified
either modified cash or modified accrual basis.
In the case of modified cash, cash receipts and
disbursements made in a budget year are recorded
2 Accrual Accounting
and reported up to a specified period after year
end. While in the case of modified accrual, the
accrual basis is used with some exceptions like
assets (e.g., fixed assets) or liabilities, not
recognized.
A good measure of an entity’s operating
strength is the economic result of a period, and a
clear public signal of this fundamental strength is
the accounting result. But the accounting result
differs from cash basis to an accrual basis of
accounting, and for this reason, the accounting
literature has extensively researched the precision
or ability of an accounting system to capture the
reality of economic transactions. The source of
accuracy accounting arises from the following
problem: period t cash flows are not period t
economic earnings. For example, the manager
may have spent cash on investments that will
pay back in the future, so the cash outflow is not
a purely economic loss. Alternatively, assets may
have declined in value leading to economic loss,
but there is no cash flow impact because the goods
are not sold. Accounting, therefore, adjusts the
operating cash flows (cash-basis accounting) to
construct a measure of operating earnings. This
adjustment is called accruals (accrual-basis
accounting).
The need for this method arose out of the
increasing complexity of an entity’s operations
and a desire for more accurate financial informa-
tion. According to accrual accounting, the events
should also be reflected in the financial statements
during the same reporting period as that of trans-
actions, given a more precise image of entity’s
current financial condition.
Accrual Accounting Influence on
Financial Statements
Accrual-based financial statements contain a more
comprehensive set of information than that
provided by cash-based statements. They inform
the users about past transactions with cash
movements during the reporting period, the
entity’s resource, and future events like obliga-
tions to pay cash or consume other entity’s
resources at the reporting date. In comparison
with another accounting basis, accrual basis
provides information about past transactions and
other events, very useful to decision-makers and
for accountability purposes (IPSASB 2014).
Accrual-basis financial statements set include
the following: financial position, financial perfor-
mance, cash flow, changes in net assets/equity,
budget execution, and notes. The main elements
of accrual-basis financial statements are assets,
liabilities, revenues, expenses, owners’ contribu-
tions, and distributions.
• Assets represent resources controlled by an
entity at present, the result of a past event.
• Liabilities are the current obligation of an
entity for resources’ outflow that results from
a past event.
• Revenues are increases in the net financial
position of the entity, other than arising from
ownership contributions.
• Expenses are decreases in the net financial
position of the entity, other than those resulting
from the owners’ contributions.
• Owners’ contributions are inflows of owners’
resources, which establish or increase interest
in the net financial position of the entity.
• Owners’ distributions are outflows of
resources from the entity, distributed to
owners, which return or reduce an interest in
the net financial position of the entity.
Only by the use of the accrual basis of account-
ing, an entity respects the matching principle by
reporting expense on its statement of financial
performance in the same period as the related
revenues. According to the accrual basis, eco-
nomic events are recognized by matching reve-
nues to expenses at the time in which the
transaction occurs, either when a flow of money
appears. By deduction, totals of expenditures and
income are recognized in the financial statements,
whether or not were flows of cash in that period.
There are three different influences of expenses
on the balance sheet. If the expense payment is
made at the time the expense was incurred, it will
be a decrease in cash. If there will be a future
payment of the expense, it will be an increase in
accounts payable. And, if the expense was paid in
advance, it will be a decrease in prepaid expenses.
Accrual Accounting
The financial performance statement reflects
revenues when they are earned – which often
occurs before the cash is received from the cus-
tomers. Similarly, as in the case of expenses, there
are three different influences of the revenues in the
balance sheet. If the service or sale were for cash,
it would be an increase in cash. If the service were
performed on credit, it would be increased in
accounts receivable. If the customer had paid in
advance for the service and the service was
conducted afterward, it would be a decrease in
unearned revenues.
At the end of the period under the accrual-basis
accounting, the time differences in recognizing
revenues and expenses result in the following
adjusting entries:
A. Accrued revenue/expenses are recognized
before cash is received/paid, using receivables
and liabilities accounts.
B. Deferred revenues/expenditures are recog-
nized after cash is received/paid, using receiv-
ables and liabilities accounts.
This method provides a more accurate picture
of the entity’s current financial performance and
position. On the one side, all of the revenues
earned during the period and the other side, all
of the expenses incurred to obtain the revenues,
according to the accrual basis, will be presented in
the income statement. And all assets that were
earned are reported, and all liabilities that were
incurred will be reported. Cash-basis information
is provided in the statement of cash flows that
present inflow and outflow of cash grouped with
operating, investing, and financing activities.
Shifting from Cash to Accrual
Accounting in the Public Sector
The cash-basis system was considered for a long
time as being perfect for the public sector account-
ing and budgeting, being also sustained by the
supreme principle of compliance with rules and
regulations. However, over the last 30 years, there
has been a shift in the orientation of accounting
and budgeting systems in the public sector from
3
cash to accruals, because of numerous changes
and an increased complexity of public sector
activities across the world, categorized as New
Public Management (NPM) characteristics.
The movement from cash to accrual account-
ing in public sector is significant because it is
supposed to go from a strict situation of cashed
incomes and paid expenses to a situation where
the emphasis is on achievements in performance
conditions.
According to the accrual-basis system, the
emphasis is on efficiency.
During the last 30 years, the number of coun-
tries having moved or moving toward accrual
accounting at different government levels
(central, regional, local) has increased, but still
nowadays, the world’s governments are evenly
split between cash-basis and accrual-basis
systems.
Since the late 1980s, only Australia and
New Zealand recorded a significant movement
toward accruals-basis accounting in the public
sector. The proponents were claiming that it pro-
vides new and, arguably, better information deci-
sion on the balance between current and capital
expenditure, taking into account the opportunity
cost of capital and its consumption over time.
Then, the trend extended to other countries
where there is a strong influence of the manage-
ment philosophy, as the UK and the USA. The
transition approach differs around the globe, from
a total shift toward accrual accounting (the New
Zeeland case, in 1992) to gradual changes in dif-
ferent regions (e.g., in the case of USA), or differ-
ent level of governments and institutions. In the
UK, accrual accounting was introduced for local
authority accounts from the mid-nineteenth cen-
tury and for the National Health services at the
beginning of the 1990s. Then in 1993 accrual-
basis accounting was proposed to be accepted by
the central authority and was subsequently
implemented (until 2001) (Hyndman and
Connolly 2011).
Nowadays in Europe, accrual accounting is
used more and more by national governments:
17 EU member states already use accrual account-
ing (PWC 2014), and several others are in the
process of switching to it. The member states
4 Accrual Accounting
develop their country-specific rules for accrual
accounting in the public sector basis according
with the International Public Sector Accounting
Standards (IPSAS). There are a lot of countries,
defined by pluralism and diversity which apply
accrual at different or all levels of government
(Caperchione and Lapsley 2011; Busca et al.
2015; Manes-Rossi et al. 2016) or with the inten-
tion to use accrual or which have started the
implementation process of accrual. But the move
to the accrual basis for public sector financial
reporting has not gained universal acceptance; a
lot of countries are circumspect about accrual-
basis accounting and budgeting in the public
sector.
For example, in 2010, the German federal gov-
ernment abandoned its accrual-basis budgeting
and accounting reform. The main reason for this
action was the parliamentarian concerns about the
loss of their control over the budget and the gov-
ernment’s finances (Jones and Luder 2011).
The use of accrual basis for accounting is
widespread in many countries, but the status is
not the same as the budget. Most states, even if
they apply accrual basis for accounting, prefer to
apply cash basis for budgeting or use accruals to
only a limited number of transactions in the bud-
get (Anessi-Pessina et al. 2016). The accrual bud-
get is not so popular because is believed to risk
budget discipline and affect the control of public
money and there is a legislature’s general resis-
tance to its adoption, due to the complexity of
accruals (Blöndal 2003).
Pro and Cons of Accrual Accounting in
Public Sector Entities
In this context, there have been many pro and con
debates of accrual accounting in the public sector
and over the benefits and risks of using accrual
basis in public sector accounting. But the
expected benefits are overwhelmingly more
significant in comparison to the drawbacks, and,
thus, an increasing number of governments
initiate the adoption of accrual accounting
(Guthrie 1998).
Accrual accounting is considered a component
of managerialism and New Public Management
(NPM). The most cited arguments for accrual
accounting refers to providing a transparent,
clear, and pertinent imagine regarding financial/
nonfinancial performance of public institutions
(Guthrie 1998), increasing the external account-
ability (Ryan 1998) and the capacity to reasonably
reflect the patrimony (Kober et al. 2010).
Another group of arguments relates to the
capacity to obtain full cost information, a critical
element for improved organizational planning,
controlling, and accountability (Chan 2003),
budgeting and allocation of financial resources,
outsourcing decisions, service costs evaluation,
and internal accountability (Likierman 2000).
The accrual accounting benefits, according to
FEE (2016), IFAC (2013), and Khan and Meyers
(2009), are as follows:
• Using assets effectively, because accrual
accounting requires complete recording of all
assets that are relevant to the overall stance of
fiscal policy and financial sustainability.
• Managing liabilities, because under accrual
accounting, both financial and nonfinancial lia-
bilities have to be reported in the annual
accounts such as accounts payable for the
receipt of goods and services and employee
liabilities like for civil service pensions and
provide a broader measure of the burden of
government financial commitments.
• Managing performance, by having a more
complete and realistic picture of costs for a
particular reporting period and the total cost
of a government’s activities, essential for
assessing the efficiency of public services.
• Addressing the citizens’ right to know whether
public services represent value for money.
• Increasing the comparability between the
financial position and performance of the EU
member states.
• Giving a complete picture of governments’
revenue and expenses, allowing them to initi-
ate action at an early enough stage, thereby
preserving assets for future generations.
• Contributing to long-term planning and assist
governments in sustainable decision-making.
Accrual Accounting
On an opposite position, some researchers con-
sider evident that the expected benefits of accrual
accounting cannot be achieved (Cohen et al.
2013) or implementing accrual basis in this sector
in not useful or necessary (Nasi and Steccolini
2008). The top of the disadvantages of accrual
accounting basis list includes some of the follow
items. To record some financial events, more
transactions are required. At the end of the period,
there are more complex requirements to calculate
and manage the adjustments. The accrual account-
ing implementation often requires professional
accounting training. Professional judgment is
used to identify the timing and scope of revenues
and expense. The preparation of the financial
reports takes longer since income/expense adjust-
ments require additional investigation.
Also, there are some suspicions considering
that the accrual adjustments are relevant, but
their reliability can be imperfect. Specifically, reli-
ability or precision can be impaired because man-
agement can make estimation mistakes or can
misuse its discretion over accruals to conceal eco-
nomic reality, or the possibility to recognize and
assets correctly.
The acceptance of accrual accounting in the
public sector has not been unanimous. Some
researchers express serious doubts about the
applicability of accrual accounting in the public
sector. They invoke the fact that the accrual tech-
niques have been specifically designed to serve
the needs of private firms. Other issues are the
measurement problems, lack of theoretical sup-
port and increased subjectivity (Chan 2003), and
the diverse nature of accountability in the public
sector. Guthrie (1998) considers that accrual
accounting does not measure outcomes, and
accrual accounting provides a small idea of per-
formance, focusing on the cost of services and
efficiency. An important topic is also related to
the difficulty and costs of implementation. All of
these should be considered reasons why a devel-
oped country refused to adopt IPSAS standards,
basis to accrual accounting.
5
Supporters of Accrual in Public Sector
There are a lot of important supporters of accrual
basis in public sector accounting like IFAC, who
issued IPSAS based on accrual accounting, WB,
OECD, and IMF at an international level and FEE
and EU Commission on the European scale.
IFAC and IPSASB have commented exten-
sively on the advantages of accrual accounting
for governments with different occasions and in
various reports and studies. IMF, also a supporter
of accrual accounting, considers the recent evolu-
tion of accrual accounting implementation in pub-
lic sector in different states as an explicit
recognition of the limits of cash accounting.
A significant contribution to the spread of accrual
accounting in the public sector is due to the devel-
opment of accrual-based international standards
for accounting (IPSAS) and government fiscal
and financial reporting (GFSM). Moreover, the
professionalization of the government accounting
staff, the implementation of private sector tech-
niques into the public sector, and the advent of
computerized financial management information
systems (FMISs) which significantly reduce the
transaction costs of collecting and consolidating
accrual-based information are strong arguments
(IMF 2016).
At a European level, the European Commis-
sion/Eurostat (2013) underlines the fact that
“Accruals accounting is the only accepted basis
that provides an accurate image of the financial
and economic position and performance of a gov-
ernment [. . .]”. In line with this, FEE supports the
move from cash to accrual accounting by issuing
statements in connection with accrual accounting
and organizing workshops and conference on this
theme. FEE aims at highlighting some of the main
advantages of adopting accrual accounting and its
contribution to governments’ financial decision-
making process. Accrual accounting supports
macro fiscal policy and a better management of
assets and liabilities by measuring assets and lia-
bilities relevant to the overall stance of fiscal
policy and fiscal sustainability, but which are not
measured by cash accounting (e.g., accounts pay-
able, employee pension liability, PPP).
6 Accrual Accounting
At the same time, the countries which decide to
pass from cash accounting to accrual accounting
are warned by IFAC to analyze very carefully the
validity and the benefits expected from this reform
taking into account the conditions, the priorities,
and the local characteristics. Also, the European
Federation of Accountants issued a paper
outlining the risks involved and explaining the
essential preconditions for the successful imple-
mentation of accrual accounting.
Conclusions
Even if the accrual accounting system is for some
authors accurate and suitable for the private sec-
tor, it gained over the last 30 years more adepts in
the public sector. There are a lot of arguments for
this, leading to the idea that accrual accounting
would provide more appropriate information for
decision-makers and lead to better decision-
making.
If accrual accounting adoption in public sector
accounting will reach its goals, it is too early to
express an opinion. However, a complete analysis
will be possible in the future, after some years of
application.
Despite the limited empirical evidence of its
usefulness in the public sector and the reserva-
tions expressed by academics, the adoption of
accrual accounting is regarded nowadays, as
self-evident (Deaconu et al. 2011).
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