What is the reason why most bank are require accrual based financial statements? This article will help provide a better
|understand of the complexity of the situation and express an enhanced perceptive of the policies regarding accrual accounting. Just because companies collect cash from customers and pay bills in cash dose not mean this is the best way to record revenues and expenses.|
The Differences Between Cash Basis and Accrual Basis Measure of Performance
The cash basis and accrual basis accounting have distinct differences in many ways. This is because basis and accrual accounting have different ways of measuring and recording revenues and expenses. The definitive differences are that cash based accounting measures the difference in cash recipes and cash disbursements during a reporting period.
Cash accounting defers all credit transactions to a later date. It is more conservative for the seller in that it does not record revenue until cash receipt. In a growing company, this results in a lower income compared to accrual-basis accounting.
In contrast, accrual accounting measures an entity’s accomplishments and resource sacrifices during the period, regardless of when cash is received or paid. Accrual basis accounting is the method of accounting that most businesses and professionals are required to use by law. Accrual accounting gives a better perspective on the company’s revenues and expenses. Using accrual accounting, receivables and payables are recognized when a sale is agreed to, even though as yet no cash has been received or paid out. According to investopedia.com (2000) Accrual accounting is considered to be the standard accounting practice for most companies, with the exception of very small operations. This method provides a more accurate picture of the company’s current condition.
Why, in Most Cases, Dose Accrual Basis Net Income Provides a Better Measure of Performing Than Net Operating Cash Flow?
For most companies accrual accounting is the method that is preferred. This is because it provides better measure of performance than
|net operating cash flow. For example, when a company enters a contract to provide a good or service it is understood that the ultimate goal is to receive cash after the performance is completed. The test for companies choosing cash base or accrual accounting, is deciding when revenue is earned. Revenue is generated as a|
result of a business provides a good or service in an economic exchange; however, when we are owed money, accounts receivable is still considered an asset even if we have not received a cash payment yet. If the company were to use cash base accounting, we will see more shortage in cash flow and it will give an unfavorable portrait of the company’s long-term cash-generating ability. On the other hand, Accrual basis takes into account the fact that a business entity’s life will extend into the future, beyond the current period. Hence, most companies use the accrual accounting method.
The Purpose of Adjusting Entries As They Relate To The Difference Between Cash and Accounting
The purpose for adjusting entries in accrual and cash basis accounting is to properly record expenses and revenues in the proper accounting period. When an adjustment is made we recognize that sometimes incorrect entries are made and need to be corrected. In cash basis accounting adjusting entries are made in the period that is currently being recorded. For example, if a company realizes that it incurred an extra expense for last year’s utilities, the cash basis accounting will just record the current year’s income statement with the extra expense. In accrual accounting an adjusting entry would be recorded in the previous year’s income statement.
Spiceland, David, James Sepe, and Lawrence Tomassini. Intermediate Accounting. 4th. New York, NY: McGraw-Hill, 2006.
Van Gieson, D. E.. “CASH BASIS VS ACCRUAL BASIS.” CASH BASIS vs ACCRUAL BASIS . 2006. KCC. 30 Oct 2006
Ward, Susan. “Basis Accounting versus Cash Basis Accounting .” Accrual Basis Accounting. 2006. About.com. 30 Oct 2006