Accounting is the mathematical representation used to collect, record, and compile financial information for the intended end users. Usually, businesses use either cash or accrual basis accounting to represent their financial situation. Under accrual basis, businesses record transactions as they occur including revenue, expenses, and income. On the other hand, under cash basis, companies record revenue when they receive cash and an expense when they pay out cash (Weygandt, 2013). Business organizations may choose one of the two basis of accounting, but should first evaluate their advantages and disadvantages. Based on the “Cash and Accrual – Conceptual” video, we explore the advantages and disadvantages of using both the cash and accrual basis of accounting to determine the one that provides the most useful information to users.
Advantages and disadvantages of Cash Basis vs. Accrual Financing
Ideally, the cash basis is the simplest method to use in business accounting. The method is also the least expensive to operate. However, as Weygandt (2013) notes, the cash basis may seem appealing but is associated with producing misleading financial statements. The cash basis fails to record revenue earned except for that which it has received cash. Consequently, the method fails to match expenses with earned revenue and does not follow the generally accepted accounting principles (GAAP).
One of the advantages of accrual basis is that it provides the most accurate financial representation of business assuming that accurate and updated records are maintained. The method requires all transactions affecting the organization to be recorded. The method also allows direct matching between company expenditure and revenue. However, as McKinney (2004) notes the accrual basis also has disadvantages – the added costs and requires extra knowledge, experience, and training to use it. Consistently, based on the evaluation it is clear that the accrual basis is the most useful basis of accounting and provides the most useful information to users. However, due to the added costs and technical know-how required on the accrual basis, cash basis is the most appropriate for small businesses and individuals.
Types of Businesses that use Cash or Accrual Basis of Accounting
Usually, the cash basis of accounting is popular with individuals, small businesses, and small government agencies because they often have few receivables and payables. On the other hand, the accrual basis is popular with large private and non-profit organizations.
AccountingWITT. (2010). Cash and Accrual – Conceptual. YouTube. Retrieved from: https://www.youtube.com/watch?v=aPwdgUDXkkE&feature=youtu.be
McKinney, J. B. (2004). Effective financial management in public and nonprofit agencies. Westport, CT: Praeger.
Weygandt, J. J. (2013). Accounting Principles, Volume I, 11th Edition. John Wiley & Sons.
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