Accrual and Cash Basis Accounting Commercial accounting and generally accepted accounting principles, generally prescribe the accrual basis of accounting over the cash basis. Describe both bases of accounting and explain the differences. Cash basis is used mostly by small businesses where owners and creditors want a simple way to understand the financial statements. Cash basis is used when a company or creditors does not worry about the accuracy of the statements but just want to understand if there is profit or loss in the company. Revenues are recorded when cash is received and expenses are recorded when cash is payment.
Generally accepted accounting principles prescribe the accrual basis of accounting over the cash basis of accounting. The accrual basis of accounting measures the performance of a business by showing in detail every transaction regardless of when the funds are received. Cash basis of accounting only accredits earnings and expenses when money is really being paid out or received. The cash basis of accounting is a less expensive way of keeping records but the failure of using this method is that financing is very difficult because of inaccuracy. The big difference between accrual and cash basis of accounting is when one uses cash basis entries are recorded at the time payment is received.
According to "Accrual" (2012),” Cash-basis accounting does not recognize promise to pay or expectations to receive money or service in the future, such as payables, receivables, and prepaid expenses”. Cash basis accounting is a simple and inexpensive method to implement and utilize. Small business owners without a strong accounting background often use cash basis accounting. Even though, both cash basis accounting and accrual basis accounting are approved accounting methods for tax purposes, only accrual basis accounting is generally accepted accounting principles (GAAP). Generally accepted accounting principles requires certain companies to use the accrual basis accounting to
This means that the owner of a business should not place any personal assets on the business balance sheet. The balance sheet of the business must reflect the financial position of the business alone. Also, when transactions of the business are recorded, any personal
There are three forms of businesses, the sole proprietorship, partnership and companies. The default option is to be a sole proprietor. With this option there are fewer forms to file than with other business organizations. The business is structured in such a manner that legal documents are not required to determine how profit-sharing from business operations will be allocated. This structure is acceptable if you are the business's sole owner and you do not need to distinguish the business from yourself.
(Kimmel, 164). In accrual basis companies recognize revenue when earned even if they do not collect cash at that time thus using the revenue recognition principle. They also recognize expenses when they are incurred even if they did not pay cash at that time which is following the matching principle. Cash basis accounting on the other hand means that the, “companies record revenue only when cash is received. They record expense only when cash is paid”.
Disadvantages include, equity dilution, cost of operating the plan, and employee risk (Major Advantages and Disadvantages of ESOPs). Simplified Employee Pension Plan The Simplified Employee Pension plan is a retirement plan according to sepira.com, for self employed and small business owners. The more traditional pension plans, the 401(k) plans are to big and cost prohibitive for a small business owner or a self employed person. The creation of the Simplified Employee Pension plan fills that gap in retirement planning for small business owners. The Internal Revenue Service says that the administration costs should be lower then more complex plans (SEP).
By using the information, manager can use cost of capital for restructure the market price and earning per share in order to bring advantage for company. By extension, it can help determine the decision whether to cancel or invest in project. Moreover, the cost of capital can help investors to determine the performance of the top management. With the intention of compare the ability of financial managers based on evaluation between the
The figures are recorded based on receipt, therefore no judgment is needed. So, historical cost is less subject to managerial discretion. Hence, the financial information is free from bias and free from error. Besides that, many assets can or must be measured at historical cost under the current accounting standards. For instances, company can choose cost model or revaluation model for property, plant, and equipment.
They typically use this method because it requires fewer journal entries for closing an accounting period and creating financial statements. I feel this method only gives the owner or company a view on the cash coming in and out but does not give the company a long term view on the overhead cost and revenue for services in order to show the company where improvements can be made or where costs