Wahid’s guess cash accounting against accrual accountingDocument Transcript
Wahid’s Guess - Cash Accounting against Accrual AccountingSummary: Accrual accounting is more accurate in terms of net income because itmatches income with the expenses incurred to produce it. It is also more realistic formeasuring business performance. A business can be going broke and still generate apositive cash basis income for several years by building accounts payableIt may appear that the company is earning a profit when in fact the company is losingmoney. It is extremely difficult to determine the actual profit or loss, because cashbasis accounting does not acknowledge money that is due or money that is owed.I hope this article will help provide a better understand of the complexity of thesituation and express an enhanced perceptive of the policies regarding Cash & accrualaccounting, Cash Basis & Accrual basis - the two main methods of recording accountingdealings are cash basis accounting and accrual basis accounting. Each method has bothadvantages and disadvantages. But, only one method is approved by generally acceptedaccounting principles (GAAP)Review of Cash & accrual basis accounting:My article discussed briefly cash and accrual. Of accounting method, the system shouldhelp with decision making in a risky environment and calculate taxable income. Themajority producers keep their records with the cash receipts and disbursementsmethod or with an accrual method.The reality of small business is that many companies keep their books on the cash basisbecause it’s simpler to understand sort of like running the business out of yourcheckbook and as it often coincides with the method they file their tax returns. On theother side, far more small businesses (and all large ones) maintain their books on theaccrual basis, frequently for one or more of three reasons:• They’re troubled about gross margin on products they sell.• They want to actually know when they’re building money and when they’re not.• They’re necessaries by lenders, investors, or government authorities to report theirtricks that way.Clarity of Cash basis accounting: -a method of accounting in which financialtransactions are recorded only when cash is involved. Similar to keeping a checkbook, asale is recorded only when the cash is received, and an expense is recorded only when acheck is written to pay for it. In the above example of income, the actual sale would notbe realized until the cash from the credit card transaction is received. With theexpense example using the cash method, the expense is not actually realized until theoffices supplies are actually paid.Clarity of Accrual basis accounting - the more common method of accounting in whichfinancial transactions are recorded when they actually happen, even if the payment ismade later. Accrual basically means to gather or to increase. With the accrual basis ofaccounting, expense and income are realized when they actually occur.
I. Income example: while a business sells a product and the customer pays with a creditcard, the income from the sale is essentially realized at the time the sale is prepared.II. Expense example: If the company buys office supply and is given 30 days to pay, theexpense is essentially posted (accrued) at the time the supplies are received.Cash Basis Accounting versus Accrual Basis Accounting01. Cash basis accounting: The main difference between accrual basis and cash basisaccounting is the time at which income and expenses are recognized and recorded. Thecash basis method generally recognizes income when cash is received and expenses whencash is paid.Accrual basis accounting: the accrual method recognizes income when it is earned (thecreation of assets such as accounts receivable) and expenses when they are incurred(the creation of liabilities such as accounts payable).02. Cash basis accounting: Cash basis accounting is the method in which cash proceedsand cash payments are recorded through the period in which they occur under the cashbasis accounting method, the revenue is recognized when the cash is received and theexpense is recognized when the cash is disbursed. "Cash-basis accounting does notrecognize promises to pay or opportunity to receive money or service in the future, suchas payables, receivables, and prepaid expenses"Accrual basis accounting: When revenue is recognized before cash is received, it isrecorded in an accrued revenue account, such as accounts receivable. When revenue isrecognized after cash has been received, it is recorded in a deferred revenue account,such as unearned revenue. When an expense is recognized before cash is paid, it isrecorded in an accrued expense account, such as accounts payable03. Cash basis accounting: there is no inventory account under the cash basis method.Goods and materials purchased for sale are recorded as direct costs in the period thatpayment is made for those goods and materials.Accrual basis accounting: the inventory account is used under the accrual basis method.Goods and materials purchased for sale are recorded as current assets, and cost ofgoods sold are recorded in the period that the goods are actually soldApply by generally accepted accounting principles (GAAP)There are two ways companies can keep their accounting books - Accrual and Cash-Basis.The accrual basis is used by most companies; only very small businesses use cash-basis.Under the accrual method, expenses and revenue are recognized in the period theyoccur regardless of whether a cash transaction has occurred. For example, if a sale ismade in January but payment is not expected until February, the revenue from the salewould be recognized in January (when it was earned) and the amount due to the companyis recorded (accrued) in accounts receivable. Below are the Journal entries for the "saleon account" and the "payment on account".
General JournalDate Account Titles/Explanation Ref Debit Credit2010.November.05Accounts ReceivableSales RevenueSale on Account5000.005000.002010.December.05 CashAccounts ReceivablePayment on Account5000.005000.00General JournalDate Account Titles/Explanation Ref Debit Credit2010.December.05 CashSales RevenueReceived Cash from Sale5000.005000.00Notice that the first entry above recognizes the sale in January, when it actuallyoccurred. This method matches the revenue from the sale to the expenses incurredduring the same period. On the other hand, under the cash-basis method, the revenuewould not be recorded until February when the cash is actually received, as in theexample journal entry below.While this method is easier and requires fewer journal entries, the sale revenue wouldnot be matched-up to the expenses the company incurred to make the sale possible. Forexample, consider the salespersons salary that made the sale. Assume payroll expenseis recorded in January. Since the revenue is not recognized until the next period(month), the accounting records do not portray a true picture of what actually occurred.Under the cash-basis method, this mismatching of expenses and revenues would alsooccur if payment was received right away (in January), but the salespersons salarieswhere not paid until February.Conclusion: All publicly traded companies publish their financial statements usingaccrual-basis method the accrual basis is also "required for all businesses that handleinventory” If the accrual basis method is used, it must be used for all financial reportingpurposes. However, those that operate multiple businesses may use different accountingmethods for each business.
My aim is not to tell which accounting method is best for you although like mostprofessionals I prefer accrual accounting because it gives most business owners so muchmore helpful information. Rather, I want to help you understand the differencesbetween accounting methods so you can make the better choice. But regardless of whichmethod you use, you’ll keep in mind the importance of looking at the other method insome fashion, so you can get the benefit of the managementPublished by: Articlesbase.com