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Cash Basis vs Accrual Basis Accounting

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Compare and Contrast Cash Basis Accounting and Accrual Basis Accounting The major objectives for business entity are to earn profit. Every company keeps their financial records and prepares their financial reports. There are two main accounting methods which are used to keep recording of the business. They are cash basis accounting (cash method) and accrual basis (accrual method). Either of any method can use in businesses. Company can choose the method which is benefit for them. The cash basis is the most simple in that the accounting records are kept on the actual flow of cash in and out of the business. Revenues are recorded when cash (or cheque) is received and expenses are recorded when they are actually paid. The cash basis is approach is used by small business entities and sole proprietors who are conduct most of their activities in cash. In this way income and expense is more accurate. Moreover the cash basis justified for a business because they have few receivables and payables. Accrual basis is a accounting method which transactions are counted when the item is delivered or the service occurs. Accrual basis of accounting, revenue is recognized in the period in which a business sells goods or performs services. This means revenues are recorded when they are earned, even though the cash transactions to support them occur later. And expenses are recorded when they are incurred, this may be before or after they are paid. For example, if your company sold $1000 furniture in January 1 2009 but was paid in January 15, 2009, after the furniture was shipped. In the accrual basis, the credit of the $1000 would be counted on January 1st, even though it had not yet been realized. Under the cash basis accounting system would record that $1000 on January 5th, the day the cash is realized. Cash basis accounting recognizes income when money is received. Accrual basis accounting recognizes income when goods are shipped. Therefore, income is entered into their accounting ledger even though payment has not yet been received. For instance your income ledger may show thousands of dollars in sales, while in reality your bank account is empty because your customers haven’t paid you yet. This method has the advantage of tracking upcoming expenses and income for better future planning. In some cases, if in a given period business collect little or no receivables and business pay lot of bills. Under the accrual basis of accounting, it doesn’t care whether you have collected or paid your bills. Income (received or not) is matched to an expense (paid or not) resulting in a proper match of revenue, with the expense generated to produce the revenue. This provides a true picture of operations. Under the cash basis accounting, if business recorded expenses without income. Thus the business lost their money. On other hand, business collects a lot of money and don’t pay their bills, business become a big income. As a result of this method it gives inaccurate revenue so that cash basis leads to misleading financial statements. The cash basis does not provide a true and their view of the financial performance and it is not good fir manufacturing operations. When goods and services are performed on credit, this method does not recognize revenues. For example, Construction Company takes a machine (such as truck) on credit. But under the accrual basis of accounting recognize the revenue and keep track of account receivable. Therefore using accrual basis in business tracking financial reports are more meanful because accrual basis matches the revenue to the time period in which it is earned or accrued. Accrual basis is generally required to be used in order to confirm to generally accepted accounting principles (GAAP) in preparing financial statements for external users. The cash basis accounting is not in accordance with the generally accepted accounting principles (GAAP). It is used only in selected situations such as very small businesses (when permitted) for income tax reporting. In addition, Accrual basis accounting matches revenues to the time period in which they are earned and matches expenses to the time period in which they are incurred. While it gives much more detail information on your business than cash basis. In modern world accrual basis of accounting is used in businesses for its extra benefits than cash basis. As far as I am concerting for accounting purposes, the best method, regardless of the type of business is the accrual basis accounting method. Since cash basis accounting can distort the true operations of your business, and incorrectly reflect income. Reference =>Cash basis, investorglossary, retrived may 13,2008 from http://investorglossary. com,html =>Accounting methods, answers, retrived may 8,2009,from http://www. answers. com =>Accrual Accounting, www. entrepreneur. com,encyclopedia,term,html
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