Accrual versus cash basis accounting Revenue and expenses

Category: Accounting

Cash basis accounting will only take note of the revenue if the cash is received; it will not take note when the sale is actually happen. It also will not record the expenses if the money has not paid, and only record when the money is paid, it will not record when the expense was made. Whereas, accrual basis accounting record the revenues when the sale or service is conduct and record the expenses when it occur. The profit of accrual normally might not same with the cash flow. Accrual basis accounting is more accepted by the business to record their transaction. It is because accrual method is recognized and need by Australian Accounting Standard and The Generally Accepted Accounting Principles. Accrual method might offer more complete data when compare with cash basis accounting.

Introduction

When a businessman want to start a business, they will decide which method use to record their accounting transaction either cash basis accounting or accrual basis accounting. The contrast of these two methods is the way the business writes down their cash transaction.

Accrual versus cash-basis accounting

The revenues and expenses may be identified by cash basis or accrual basis. Cash basis accounting will only record when the cash is already received or paid and did not consider those depreciation, payables and receivables. Usually a very small business will choose to use this method to record their cash transaction because normally their business activities conduct most in cash. By using this method, the revenues are record when the money is received, whereas expenses are record if the money is paid. By this way, net profit will excess of cash flow from revenues and over cash outflows for expenses. This method does not take note the revenue when product is sold or services are performed on credit. Moreover, the costs of goods and services used during the current period to produce revenue, but no paid for, are recognized as expenses in a subsequent period when cash is paid. Therefore the cash basis method just recognized the revenues and expenses if the amount of inflow and outflow can be measured on a maximum degree of certainty. (Hoggett & Edwards, 1990)

Accrual basis accounting is concern about when the inflow of economics benefits can be measured reliably and at the same time revenue also need to recognized in that period. Videlicet, usually may under a contractual arrangement during the period that business sells their products or services. If the consumption of goods or services be able to reliable measurement the expenses can be recognized. The accrual basis net profit for an accounting period is decide by subtracting expenses recognized during the period from revenues recognized in that period. (Hoggett & Edwards, 1990)

The accrual basis accounting is different if compare with cash basis accounting, this is because the accrual basis accounting have to record the transaction when it occur and will not record the transaction when paid or received. The process of spending and collecting cash is focus by the financial statement users, "not just with beginning and end of the process" when cash is invested or cash is collected. The reason of just highlight on the process is because the process is the source of future cash flows and is what is recurring. (For more understanding can refer to appendix 1, it provide example)

In Australia and also in most countries, the accrual basis should be used in the preparation of the financial reports (Australian Accounting Standard, AASB 101, Presentation of Financial Statements). A company in Australia is required to use accrual basis because this method is the method that recognized by the Australian accounting standards. This is because accrual basis accounting may provide a more complete portrayal of financial position and operating performance. (Horngren et al. 2006)

The accrual basis is also recognized by The Generally Accepted Accounting Principles (GAAP), this is because the indication of the company's financial statement like stability finance of the company or the activities for the company to generate income, it must be true and actual because it will provide the investors actual information to do their decision making. Retrieve from Accrual versus Cash-Basis Accounting.

Modern business activities are largely conducted on credit and often involve long and complex financial arrangements. An enterprise's inventory, plant, receivables and payable, investment, property, equipment, and other noncash resources and obligations are links between its operations and other transactions, events and circumstances that affect it and its cash receipts and expenditures. For example, labor is often used by an enterprise before it is paid for, requiring that salaries and wages payable be accrued to recognize the obligation and to measure the effects on earnings in the period the labor is used rather than when the payroll checks are issued. Conversely, resources such as raw materials and equipment may be paid for by an enterprise in a period that does not coincide with their use, requiring that the resources on hand are recognized and the effect on earnings be deferred until the period the resources are used. Similarly, receivables and the related effects on earnings must often be accrued before the related cash is received, or obligations must be recognized when cash is received and the effects on earnings must be identified with the periods in which goods or services are provided.

The goal of accrual and deferral of benefits and sacrifices is to relate the accomplishments and their efforts so that reported earnings measure an enterprise's performance during the period instead of merely listing cash receipts and outlays. (Hartman et al. 2000)

Conclusion

The accrual basis accounting can give a more complete data if compare with cash basis accounting system. If the information complete will assist the decision-maker to make better decisions therefore can as soon as possible to arrive conclusions and that related to the firm's financial health and may predict future's financial condition. If the method to use the accrual accounting is true and actual, the many of financial scandals that happened lately might been prevent.