Cash Basis Accounting Versus Accrual Accounting Method: Matching And Revenue Recognition Principles.

1256 words - 5 pages

Introduction
To account for profit, businesses have an option of choosing between two methods of record keeping; that is the accrual basis method and the accounting basis method. Using one method throughout accounting period and then changing it at the end while determining profit, might introduce a form of biasness and hence resulting in inaccurate figures. The two methods are completely different in terms of how revenue and expenses are recognized and recorded. As a result, the accounting for profit between the two is also poles apart. In the accrual based method, revenues and expenses are recorded once they are earned or incurred regardless of whether a cash transaction has been conducted or not (Mills, Call & Drew 2000). This therefore implies that for the profit of a specific accounting period to be determined or measured, the revenue earned during that period has to be matched with the expenses or the cost incurred while striving to earn that revenue (Anderson 2002). Cash basis accounting diverts from this statement in a number of ways.
Accrual and Cash-based Accounting
As already hinted, how profit for the period is accounted for, spells out the major difference in the two methods. During record keeping, a process that eventually leads to determining the accounting profit, accrual basis of accounting follows to the letter the revenue recognition principle and matching principle. The revenue recognition principle must be in line with accounting period convection. This convection dictates that the life of a business entity can be divided into equal period; along with this the revenue recognition principle directs for revenue to be accounted for in the period which they are earned. At the end of each period, the financial position of a business entity must be highlighted by preparing and presenting the financial statement (Mills, Call & Drew 2000). It is these report that highlights the profitability of an organization. The matching principle, which as another requirement for accrual accounting basis, dictates the matching of revenue of a period to the expenses incurred to earn them in the specified period (Andrew 2002).
It is due to the adherence of these principles that makes Accrual basis of accounting, as oppose to cash base accounting method, to be endorsed by the General accepted accounting Principles (GAAP) (Cudia 2008).Cash based accounting does not utilize the matching concept. Similarly the revenue recognition criterion in this method is quite different. A business owner using this method has an option of not conforming to the accounting period convection. It is the above factors that make this method not to be certified by GAAP (Sayther & Mathieu 2003). Nevertheless, the method is still useful to small business owners, who probably have little or no investor or creditors. In the same way, it is useful to professionals who exchange their services for cash, such contracted engineer (Carter 2003).
Determining Profit
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