Accounting Essay

1281 words - 6 pages

Cash vs. accrual: Is there a difference in recognizing transactions?

ACC205: Principles of Accounting I


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Cash vs. accrual: Is there a difference in recognizing transactions?

Cash and accrual based accounting are two ways use to record revenue or expense transactions. However, there is a difference in recognizing cash and accrual accounting transactions. Moreover, in cash basis accounting, a transaction is recognized when the money changes hands. Therefore, cash receipts are treated as revenue and payments are treated as an expense. However, in accrual basis accounting, it records the effect of ...view middle of the document...

You give the cashier the money and you walk out of the door with the product that you just purchased. The sale is considered complete and you are now the proud owner of your item. The store owner will record this sale as a cash transaction because the item was paid and them item was delivered. Thus, the transaction is completed.

Cash basis accounting is not generally accepted in business. However, “Very small companies start out by using the cash basis. It's easy and tracks cash flow which is the lifeblood of a company.” (Capital, 2011) However, this reporting method is not acceptable. Yes, it shows your businesses cash flow accurately. But, it does not give an accurate view of your overall business revenue and expenses. Because, income is recognized only when cash is received for the sale or paid for an expense, you really cannot use cash basis for your accounting if you sell or purchase products on credit with a delayed billing method. That is where accrual basis accounting comes into play.

Most companies today, even the small ones, are using accrual basis accounting. “Accrual basis does a great job matching revenues and expenses and gives you a more complete picture of what is going on in your business.” (Capital, 2011) The accrual basis of accounting records transactions as they occur. Cash does not have to change hands, but a transaction must have occurred. The accrual basis of accounting for revenue and expenses gives the business owner a better handle on the company’s profits and losses. Moreover,

The creation and reduction in net operating assets is what defines accrual accounting, and the timing of those accruals is well understood to affect both current and future earnings. When current period accruals are income increasing, earnings have effectively been borrowed from future periods. Firms in this case will, all else equal, have higher net operating assets that must eventually unwind (Barton and Simko [2002]). Conversely, income-decreasing accruals will yield future benefits in that those accounting ‘‘reserves’’ will not be a drain on future earnings. MOSEBACH & SIMKO, 2010)

Additionally, income is not recorded until you finish a service or deliver the merchandise that you have previously agreed on. Also, expenses are not recorded until the service has been completed or all of the goods have been delivered, received, installed, and completely finished. For instance you received a product that was delivered, received, installed, but a single cosmetic part is missing and must be ordered, delivered, received, and installed. The company would not recognize the expense until the product was complete with all of the parts installed.
The accrual basis accounting method can sometimes presents a serious cash problem to the firm. Although the accrual method represents a better financial picture by the recording of transactions when they actually occur, it may leave the company strapped for...

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