Accrual Basis preferred over Cash Basis
Do you think business enterprises should prepare Financial Statement? If yes, why? How is it going to affect if the financial statements are not prepared?
Well, even if you know that your business is doing well and earning good profits still you need to prepare the financial statements. You may be convinced that your business is doing fine, but you will need a proof for investors, creditors, shareholders and others. So Accounting and Financial Statements play a vital role in making right business decisions.
The main objective of accounting is to provide appropriate, useful and reliable information to the users about the financial performance of the business. In accounting there are two bases to ascertain Profit or Loss namely Cash Basis and Accrual Basis. Under the Cash basis of accounting, transactions are recorded in the books of accounts only on the receipt/ payment of cash. Under the Accrual system of accounting, revenues and expenses are recorded when they are recognized i.e., Income is recorded as Income when it is accrued i.e. when transaction takes placeirrespective of the fact whether cash is received or not.
Difference between Accrual Basis and Cash Basis
The difference between Cash and Accrual basis of accounting is important to understand the financial statements and make right decisions. The difference between the two lies in the timing of when sales and purchases are recorded in the books of accounts. When compared to Cash basis, the accrual basis of accounting provides a better picture of a company’s profits during an accounting period. The reason is that the income statement prepared under the accrual basis will report all of the revenues earned during the period and all of the expenses incurred in order to earn the revenues. The accrual basis of accounting also provides a better picture of a company’s financial position at a moment or point in time. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported. The accrual basis of accounting is required because of the matching principle.
The accrual basis of accounting gives a more realistic idea of income and expenses during the accounting period and also provides a long-term picture of the business that cash accounting doesn’t provide. In addition, the financial results of a business under the accrual basis are more likely to match revenues and expenses in the same reporting period, so that the true profitability of an organization can be discerned.