Wahid's Guess - Cash Accounting against Accrual Accounting

I hope this article will help provide a better understand of the complexity of the situation and express an enhanced perceptive of the policies regarding Cash & accrual accounting, Cash Basis & Accrual basis - the two main methods of recording accounting dealings are cash basis accounting and accrual basis accounting. Each method has both advantages and disadvantages. But, only one method is approved by generally accepted accounting principles (GAAP)

Review of Cash & accrual basis accounting:

My article discussed briefly cash and accrual. Of accounting method, the system should help with decision making in a risky environment and calculate taxable income. The majority producers keep their records with the cash receipts and disbursements method or with an accrual method.

The reality of small business is that many companies keep their books on the cash basis because it's simpler to understand sort of like running the business out of your checkbook and as it often coincides with the method they file their tax returns. On the other side, far more small businesses (and all large ones) maintain their books on the accrual 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 their tricks that way.

Clarity of Cash basis accounting:  -a method of accounting in which financial transactions are recorded only when cash is involved. Similar to keeping a checkbook, a sale is recorded only when the cash is received, and an expense is recorded only when a check is written to pay for it. In the above example of income, the actual sale would not be realized until the cash from the credit card transaction is received. With the expense example using the cash method, the expense is not actually realized until the offices supplies are actually paid.

Clarity of Accrual basis accounting - the more common method of accounting in which financial transactions are recorded when they actually happen, even if the payment is made later. Accrual basically means to gather or to increase. With the accrual basis of accounting, expense and income are realized when they actually occur.

I. Income example:  while a business sells a product and the customer pays with a credit card, 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, the expense is essentially posted (accrued) at the time the supplies are recived

Cash Basis Accounting versus Accrual Basis Accounting

01. Cash basis accounting: The main difference between accrual basis and cash basis accounting is the time at which income and expenses are recognized and recorded. The cash basis method generally recognizes income when cash is received and expenses when cash is paid.

Accrual basis accounting: the accrual method recognizes income when it is earned (the creation 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 proceeds and cash payments are recorded through the period in which they occur under the cash basis accounting method, the revenue is recognized when the cash is received and the expense is recognized when the cash is disbursed. "Cash-basis accounting does not recognize promises to pay or opportunity to receive money or service in the future, such as payables, receivables, and prepaid expenses"

Accrual basis accounting: When revenue is recognized before cash is received, it is recorded in an accrued revenue account, such as accounts receivable. When revenue is recognized 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 is recorded in an accrued expense account, such as accounts payable

03. 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 that payment 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 of goods sold are recorded in the period that the goods are actually sold

Apply 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 they occur regardless of whether a cash transaction has occurred.  For example, if a sale is made in January but payment is not expected until February, the revenue from the sale would be recognized in January (when it was earned) and the amount due to the company is recorded (accrued) in accounts receivable.  Below are the Journal entries for the "sale on account" and the "payment on account".

2010.Nov.05 : Accounts Receivable= 5000

Sales Revenue= 5000

(Sale on Account)

2010.Dec.05: Cash=5000

Accounts Receivable=5000

(Payment on Account)

2010.Dec.05 Cash=5000

Sales Revenue-500

(Received Cash from Sale)

Notice that the first entry above recognizes the sale in January, when it actually occurred. This method matches the revenue from the sale to the expenses incurred during the same period. On the other hand, under the cash-basis method, the revenue would not be recorded until February when the cash is actually received, as in the example journal entry below.

While this method is easier and requires fewer journal entries, the sale revenue would not be matched-up to the expenses the company incurred to make the sale possible.  For example, consider the salesperson's salary that made the sale. Assume payroll expense is 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 also occur if payment was received right away (in January), but the salesperson's salaries where not paid until February.

Conclusion: All publicly traded companies publish their financial statements using accrual-basis method the accrual basis is also "required for all businesses that handle inventory" If the accrual basis method is used, it must be used for all financial reporting purposes. However, those that operate multiple businesses may use different accounting methods for each business.

My aim is not to tell which accounting method is best for you although like most professionals I prefer accrual accounting because it gives most business owners so much more helpful information. Rather, I want to help you understand the differences between accounting methods so you can make the better choice. But regardless of which method you use, you'll keep in mind the importance of looking at the other method in some fashion, so you can get the benefit of the management