A COMPARISON BETWEEN CASH ACCOUNTING AND ACCRUAL ACCOUNTING 1. Introduction Accounting principle and theory are generally referred to two main accounting methods which include cash accounting and accrual accounting. Cash basis accounting on income and cost is determined by the amount of actual payment for reference and accounting recording mode is simple, easy to master. The use of the accrual basis of accounting is more complicated than it with a main difference of recording timing. This essay will firstly separately discuss related conception and theory of cash and accrual accounting.
Following this, it will explain the advantages and disadvantages of those two dealing method. Finally, it will offer two examples to describe manipulating profits in accrual accounting, then one preference selection of two main methods is given in the conclusion part. 2. Two methods for calculating performance of an accounting period Cash-basis accounting is that cash received or paid for the standard, to record the implementation of income or expenses occurred (Kelly, Tracy, 2010, p. 10).
That is to say income and expenses period should be intensively tied to cash behavior of the payment or receipts. And the accrual accounting of international accounting standards to explain: “according to accrual basis requirements, enterprises should confirm its impact in the transaction when it occurs but not in the receipt and payment of cash and cash equivalents, and they should be credited with their associated the accounting records during the period with financial report to report (Albright, Ingram, 2006, p. 83). This explains the transaction to be confirmed when items occur, rather than in the received or paid confirmation. The accrual basis of accounting practice on time referring to the main body of economic activities happened and monetary payments is not completely consistent (Hansen, Jones, Lowen, Rich, 2011. p. 110). For example, “accrued expenses are expenses that have been incurred relating to the accounting period but for which an account for the exact amount has not been received” (Elliot, Horngren, Sundem, 2010, p. 45). Here is an example to explain the usage and difference of them.
The following economy business happened this month of Some enterprise: (1) To pay the monthly electricity $5,000; (2) To receive the last month’s accounts receivable $10,000 ; (3) To receive this month’s sales income $8,000; (4) Payment for this month office expenses $900; (5) Pay next quarter insurance fees $1,800; (6) business income $25,000, not received; (7) received customer payment in advance $5,000; (8) Prepaid insurance costs $600 last quarter. The calculation of income, expense and loss is show as the following table: Table 1 Comparison between accrual accounting and cash accounting
After some introductions about conceptions about cash and accrual accounting, strengths and weaknesses of them are separately explained in the following expressions. Cash basis of accounting information provided has incomparable superiority in the two aspects: firstly, enterprise’s income cost and profit is objective and comparable in cash-basis accounting determine; Secondly, cash basis accounting reflects the enterprise the real owned cash, and whether enterprises can repay the debt, the payment of interest, dividend assignment or not depends largely on the enterprise actual possession of cash;
Two aspects shown as follows to describe the disadvantages of cash accounting: firstly, asset valuation-it is unable to properly reflect the true of the assets and not on the depreciation of fixed assets; Secondly, liabilities to reveal-it can not fully reflect the enterprise’s debt, no provision for interest expenses payable. It hides enterprise debts and exaggerates financial resources controlled by enterprise, to result in false or dummy balance.
After exploring the strengths and weaknesses of cash accounting, some information related to accrual accounting should be revealed in the following part. The accrual basis of accounting is based on continuous operation and accounting periods to divide the different accounting period assets, liabilities, incomes, expenses and other accounting elements, and the use of some such as accounts receivable, payable, accrued, deferred project to record the assets and liabilities elements.
The business is continuous, accrual accounting can more accurately reflect actual financial situation and management performance during the specific business accounting period. Two parts shown as follows to describe the weakness of accrual accounting: Firstly, profitability aspect-the accrual basis gives a confirmation to some uncollected income.
Such income is an imaginary number with some risks; Secondly, a portion of sales income in the currency can not be received and a confirmation is authorized in this situation, it will be having impact on taxation, distribution and many other aspects to result in bad chain reaction, thereby causing the financial deficiency and income distribution in advance; Furthermore, the accounting period calculation of profit does not have uniform standard for different accounting methods to select and the subjectivity is too strong, easily manipulated by the management authorities; Secondly, liquidity aspect-accrual accounting considers payment, deferred expenses, accounts receivable and inventory as current assets. Obviously, liquidity of those assets is poor, and this makes current assets liquidity enterprise off its real values. In the end, two examples are referred to net profit manipulation in accrual accounting. As known to all, the net profit of enterprise can be manipulated by manual. One example is depreciation. “The allocation of a non-current asset’s cost to expense over its useful life is called depreciation” (Elliot, Horngren, Sundem, 2010, p. 107).
The assets of enterprise, especially fixed assets, are devaluated with years gone by. In the accounting treatment, depreciation should be considered as expense to be deducted, otherwise it can cause the net profit dummy higher than the real value. The other example is bad debt. In general, bad debt should be dealt with regularly. For example, the bad debt of accounts receivable which are impossible to get should be cleared, otherwise it can make net profit increase. 3. Conclusion In conclusion, two different approaches of accounting both have strengths and weaknesses. Accrual basis accounting as the core foundation of accounting system has its obvious advantages with an unshakable solid position.
Nowadays, the combination of accrual and cash basis of accounting development has become the trend. Despite of it, accrual accounting is more preferable to be involved in our daily accounting activities. Reference Albright, T. L. , & Ingram, R. W. (2006). Financial Accounting: Information for Decisions. USA: Thomson Higher Education. Elliot, J. A. , Horngren, C. T. , & Sundem, G. L. (2010). Accounting (6th ed. ). Australia: Pearson Education. Hansen, D. , Jones, J. , Lowen, M. , & Rich, J. (2011). Cornerstones of financial Accounting. USA: south-Western Cengage Learning. Kelly, J. , & Tracy, J. A. (2010). Accounting Workbook For Dummies. England: John Wiley & sons, Ltd.