Accountants’ record of revenues and expenses does not always match the actual cash inflows and outflows. Accountants follow a number of rules that govern when revenue or expenses hit an income statement. Here are a couple of the most significant examples:

Revenue Recognition - Suppose Ajax Corp. ships out a widget to a customer, along with a $100 invoice. At that moment Ajax’ accountant would recognize revenue of $100 (under most circumstances) – even though Ajax has not received the $100 in cash yet. Ajax records a receivable on its balance sheet for the $100. Ninety days later, when the check arrives, Ajax records an entry to remove the receivable and increase its cash balance. Note that this leads to a delay between the cash impact and the (accrual) accounting impact.

Inventory Accounting – Suppose Ajax spends the entire month of January making a widget at a direct cost of $50 (e.g. the apportioned salaries of the people working on it plus the cost of raw materials). The widget sits in the warehouse for three months and is finally sold for $70 on April 30.
What if Ajax used a cash accounting method, recognizing revenues and expenses when the cash actually moves? It would have a $50 loss in the first quarter and a $70 profit in the second quarter. Instead, accountants use principles that match the revenues with the expenses. The $50 of costs are capitalized – they increase the value of the inventory on Ajax’ balance sheet. So instead of attributing the $50 of costs to an expense on the income statement, the cost is temporarily capitalized to the balance sheet. Later, when the widget is sold, $70 of revenue and $50 expense are recognized ($20 profit) and the inventory disappears.

Depreciation – Suppose Ajax spends $1,000 on a new machine. The machine is expected to last for 10 years. The accountant does not show a gigantic $1,000 expense on the income statement this year. Instead, the $1,000 is capitalized – increasing the property, plant & equipment (PP&E) line item on the balance sheet. The expense is recognized over the period of time that the benefits of the machine are received. A depreciation expense of $100 per year for the next 10 years would be a very typical treatment. An annual $100 expense is recognized on the income statement. The cash picture is different. $1,000 is spent today and none for the next 10 years.

This definition is in context to Finance. See more contextual defintions for Accrual Accounting.