The two main types of accounting are cash basis accounting and accrual basis accounting. Each method has advantages and disadvantages. However, only one method is approved by GAAP.
Cash Basis Account
Cash basis accounting is a method in which cash receipts and cash payments are recorded at the time they occur (Spiceland et al., p. 7). Under the cash basis of accounting, revenue is recognized when money is received and an expense is recognized when money is disbursed. “Cash accounting does not recognize promises to pay or expectations of receiving money or service in the future, such as payables, receivables and prepaid expenses” (Wikimedia Foundation, Inc.). In addition, there is no accounting for inventory under the cash basis method. Goods and materials purchased for sales are reported as direct expenses at the time payment is made for the goods and materials (Bituricense).
A cash-based account is a simple and inexpensive method to implement and use. It also provides an accurate representation of cash. In addition, the cash system provides the opportunity to defer taxable income billing so that “deferral taxable billing is not received in the current year …
Cash basis accounting does not comply with the two most important accounting principles: the revenue recognition principle and the matching principle. The cash recognition principle requires that revenue be recognized when the purchase is made, not when the money is received. The matching principle requires that expenses be matched against related income, not at cash time.
Since the cash basis does not recognize receivables or payables, it is not an accurate method of measuring profit (Nelson). It appears that the company is making a profit when in reality the company is losing money. It is very difficult to determine the actual profit or loss, because cash rations account does not recognize money owed or money owed.
An accurate basis for judging
The basis of accrual accounting is the way in which revenue is recognized when it is earned, and expenses are recognized when incurred. Additional accounts must be created to record the difference between the recognition of income or expenses and the receipt or disbursement of funds.
Since the revenue is recognized before the money is received, it is added to the government’s revenue as accounts receivable. When revenue is recognized after receipt of cash, it is recorded in the deferred income account as it is without interest. When an expense is recognized as a pre-paid amount, it is recorded in an additional expense account as account payable. The expense, after it is recognized that the money has been paid, is recorded in the deferred expense account as a prepaid expense (Author Unknown). In addition, the inventory system is used under the accrual basis method. Goods and materials purchased for the sale of current assets, and cost of goods sold in the period in which the goods are sold (Berry).
One disadvantage of an accrual basis account is that it is more complex and expensive to implement and use than a cash account. Another disadvantage of using the accessory basis method is that the company will owe taxes before the payment is actually received. However, accrual basis accounting “gives a truer picture of how the business is carried out over a long period of time. than the cash method” (Thomson Gale). In addition, due to compliance with revenue recognition and matching principles, accrual basis accounting is a much more accurate method of measuring profit (Nelson).
Conclusion
“The U.S. Securities and Exchange Commission requires that all companies publicly follow GAAP trading-company, so all publicly traded companies publish their financial statements using the accrual-basis method” (Wikimedia Foundation, Inc.). The accrual basis is also “required for all businesses dealing with inventory” (Thomson Gale). If an accessible method is used, it must be used for all financial purposes. However, those who operate multiple businesses may use different accounts for each business.
Additionally, businesses should report one number of books for financial purposes, and another for tax purposes. Businesses typically want to use cash accounting for tax reporting if they can, because cash accounting generally refers to taxable income ( Nelson) The IRS generally requires all businesses to report an accrual basis on their tax returns, but the IRS allows the use of a cash basis if meet certain criteria.As tax laws change frequently, a tax accountant should be consulted before deciding to use the cash basis method IRS reporting for tax purposes.
References
Author of civil law. “Accreal Basis vs. Cash Basis Accounting.” Accounting Study Guide. URL: (http://accountinginfo.com/study/accrual-101.htm); Tim Berry. “Accreal Accounting is Standard. Cash Basis is optional.” Tim Berry, Business Planning Expert. URL: (http://www.timberry.com/fm/Accrual_Accounting_is_Standard.htm); Stephen L. Nemesianus. “Accrual Basis Accounting vs. Cash Basis Accounting. Redmond & Bellevue. URL: (http://www.stephenlnelson.com/accrual_basis_vs_cash_basis_accounting.htm); Thomson Gale. “Cash vs. Accrual Basis”. Accounting Method. URL: (http://www.referenceforbusiness.com/small/A-Bo/Accounting-Methods.html); Wikipedia “Accounting”. Accrual_basis_accounting).
