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Accounting Versus Cash Based Accounting Essay

1168 words - 5 pages

PAGE PAGE 4 Accrual Versus Cash
Accrual versus Cash Based AccountingIn the cash method of accounting, you record your expenses and income when cash is exchanged. You record income when you receive payment and you record expenses when you actually pay them. This method is used most by small business owners. Cash-basis accounting is a method of bookkeeping that records financial events based on cash flows and cash position. Revenue is recognized when cash is received and expense is recognized when cash is paid. In cash-basis accounting, revenues and expenses are also called cash receipts and cash payments.Cash-basis accounting does not recognize promises to pay or expectations to receive money or service in the future, such as payables, receivables, and prepaid expenses. This is simpler for individuals and organizations that do not have significant amounts of these transactions, or when the time lag between the initiation of the transaction and the cash flow is very short.Some of the issues with cash-basis are this accounting fails to meet GAAP requirement because it does not follow the following two principles:revenue recognition principle - revenue should be recognized when it is realized (e.g. a credit sell).matching principle - revenue should be matched to the expense if possible (e.g. Sales to COGS).Additionally, cash-basis accounting is not viable for cost accounting in manufacturing operations because expense is not associated with product cost.Example:When you pay your rent your landlord would record an income event when you make the payment. The landlord records an expense event when he pays the accrual accounting versus cash-basis accounting rental agent their fee for your apartment. It is the accounting method used by most individuals, and by some businesses that have limited payables or receivables or whose accrual versus cash-basis accounting income and expense cash flows is closely associated with each other in time.Two types of Cash-basis accounting exist: strict cash-basis and modified cash-basis. Strict cash-basis follows the cash flow exactly. Modified cash-basis includes some elements from accrual-basis accounting such as inventory and property capitalization. Cash-basis accounting is used by small businesses and households. The financial statements for those entities are used by very limited amount of people.Accrual-basis accounting records financial events based on events that change your net worth (the amount owed to you less the amount you owe others). Standard practice is to record and recognize revenues and expenses in the period which they incur. Even though cash is not received or paid in a credit transaction, they are recorded because they are consequential in the future income and cash flow of the company. Accrual-basis is GAAP compliant.In the accrual method, you record income when you have made the sale or performed the work. You record expenses when you have received a good or service. This method is used more by...

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