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Accrual and Cash Based Accounting

Essay by   •  January 27, 2013  •  Essay  •  507 Words (3 Pages)  •  1,619 Views

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Accrual and Cash Based Accounting

The cash and accrual methods of accounting are two different methods that a company can use to document their financial transactions. Normally, a company will have a choice at its beginning on which of the two methods that it would like to use. American author Fred Schwed (n.d.) said, "One can't say that figures lie. But figures, as used in financial arguments, seem to have the bad habit of expressing a small part of the truth forcibly, and neglecting the other part, as do some people we know." The intent of this essay is not to persuade one into using one of these accounting methods over the other, but to describe the differences between the two methods.

The cash basis of accounting is the method that is more common in the small business tier of the business world (Fishman, n.d.). In the cash basis, the company does not document or account for revenue earned until the money is physically received for the product or service and in-turn does not report expenses until the money is paid or the supplies are consumed. This method of accounting shows a better picture of a company's actual cash standing at the end of each of the company's accounting periods. A disadvantage to the cash basis is that company's can often lose sight of how much money they are making long term, with the up and down financial periods. These up and down periods can be caused by consumers paying more during some financial periods and the company spending more during others.

The accrual basis of accounting is the method that is more common with larger companies, and even required if a company "has sales of more than $5 million per year" (Fishman, n.d.). In the accrual basis, the companies account for revenues and expenses when the transaction actually takes place, not when the money is received or the service is provided. This method depicts a company's financial standing at the end of an accounting period more accurately, because it's accounting for every penny when the transactions take place. One major problem with this method is that a company's financial standing on the end of period statements can look awesome, but because they haven't received the revenue for the services from the customers yet, they could actually be broke (Fishman, n.d.).

In conclusion, both the cash and accrual basis of accounting are very effective ways of accounting for a company's financial periods. The cash basis is more common and easier to use within small businesses and the accrual basis is required in very large ones. A company may even be able to switch from the cash method to the accrual method as their business grows.

References

Fishman,

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