The Difference between Accrual and Cash Accounting - Essay Example

ACCRUAL AND CASH ACCOUNTING Accrual and Cash Accounting Name Institution Date The Difference between Accrual and Cash Accounting The two methods of accounting are acceptable but companies select the method to be used in their business. The bottom line results are at times very different when the two methods are compared. The cash method is a method mainly used in the small businesses. In this method, expenses and income are not counted until the transactions are done i.e. a check or cash is received for income and money is paid for the expenses. Since the cash method is easy to use, the business owner can use it without the need of an accountant. On the contrary, accrual method requires one to have professional skills if he or she is to use it (Donleavy 1994). In the cash method, the money is put in the cash records immediately it is received and money is accounted for immediately it is paid or it goes out. For instance, when a customer buys computers and printers from Del Company, the money is entered in the books immediately the cash is received. However, if a university makes an order for the computer systems to be delivered and this is done, only the money received in cash or in the form of cash. Any money in dept is not recorded or any money to paid on a future day. In the same case, if Del company has services or goods that it has not paid for, for instance electricity bills, money to be paid for repairs done or the money for ordered spare parts that are not yet paid for, these figure are not entered in the books. On the other hand, accrual method takes account of every cent even if it is in dept. since Del is an international company and handles a lot of cash, it uses accrual accounting while Kerry bakers use the cash method. Accrual method is very professional and the statements are in such a way that they are in accord with the generally accepted accounting principles. This method ensures that the timing of the expenses and revenue of a business are well matched. This means that sales of services and good are recorded as soon as an invoice is received and the services or goods are delivered. Unlike in the cash method, the cost of services and goods delivered is recorded regardless of whether a company has received the cash or not. Any expense that has been incurred and is payable or due is also recorded (Donleavy 1994). This means that even if the dept will be paid next month, it is still recorded. These kinds of records are very important for the Del Company since it handles a gross sale of more than ten million dollars. This method is very important in the performance of a company since any economic event is recognized and recorded. To articulate a Del company’s current financial condition, the expected cash outflows/inflows and current cash outflows/inflows are combined. Accrual Accounting Is a Better Indicator of Future Cash Flow In any investment, predicting future cash flow is very important. Accrual method has been referred to as the most accurate method for determining this. However, there has been an inconsistency of data in the previous researches done on the accrual and cash flow accounting standards. For instance, there has not been any research done in Thailand on prediction of cash flow. A research conducted on the ability cash flow and accrual methods to predict the future cash flow indicated that accrual method is a better future cash flow predictor. The accrual method is the only method that represents a company’s financial state. For instance, Del Company some times has a lot of money in cash for goods sold and determining the future cash flow with regard to the amount of money in its accounts is misguiding since there are many debts held each month for unpaid services and received goods. In addition, this method gives accountants the accurate tax liability which is in accordance with the credit control practices and policies of the clients and suppliers and therefore makes possible to predict the future cash flow. On the contrary, tax liability may be less or higher while using the cash method. Accrual accounting has been noted to provide superior information making it easy for enterprises to predict future cash flows. In accrual accounting, different components are included to represent different information which is in relation to the future cash flows. Productivity is enhanced by amortization, depreciation, inventory change, and change in payable account, change in receivable accounts as well as other accruals recorded. Each of these components and the cash flow are more sustainable predictive of the future cash flow unlike having aggregates of earnings. Limitations of Accrual Accounting An accrual account identifies any amount of money held after a transaction has been done. Sometimes the cash in dept may not be paid in full requiring one to make an adjustment on the previous records. The cost of services and products already received are easily determined after using them. For instance, Del Company is in a position to determine the economic performance of the products received before paying for them. This method can therefore be tiresome when compared to the cash method. Under the accrual method, ensuring that taxes are minimized by expense and income items from this year to another year is very difficult. This is not the cash with the cash method where the business person is in a position to collect interests, rents any other obligation in advance wile putting off tax payment at a later date. In addition, this business man can adjust the expenses by deferring or accelerating payments such as taxes, interests, repairs, suppliers and advertisements. For accrual method, controlling the above is not as easy. Though Del Company can defer part of the income to the following year by invoicing and shipping less goods and services, it is not worth the cash flow problem which may occur. Accrual method may result to some serious cash flow problems since it does not give details on the cash reserves available (Watts and Zimmermann 1986). For instance, the income ledger prepared for Del company transactions may indicate that the company has 1 million dollars while in actual sense the account reads 1000 dollars since some clients have not paid for the goods received. This is misguiding when making decisions on what to invest. Finally, accrual accounting involves a very detailed process and requires that at each accounting period end, some closing entries be posted. This is mainly done by a hired accountant in Del Company hence costing it some extra cash. This method is therefore an expensive method to use as it increases the expenses of a company. Computation of Gross Profit Sales 191, 000, 000 Less cost of goods sold Opening stock 7, 800, 000 Add purchase 78, 000, 000 85, 800, 000 Less closing stock 9, 134, 000 76, 666, 000 Gross profit 114, 334,000 Income Statement as at 31st December for Richard PLC. Gross profit 114, 334,000 Bad debtors 600 000 Sundry expenses 2, 500,000 Motor expenses 15, 300,000 Wages and salaries 6, 600, 000 Add Unpaid salaries 500, 000 7, 100,000 Insurance 2, 500,000 Rent 10, 000,000 Add rent paid in advance 2,000, 000 12, 000,000 Director’s remuneration 21, 000,000 Depreciation Equipment less 10% of 72 000,000 7, 200,000 Interest of loan 5% of 20,000,000 1, 000,000 Motor vehicles less 50% of 48, 000,000 24, 000,000 93, 200,000 Net profit 21, 134, 000 Balance Sheet Fixed assets Cost Depreciation Book Value Motor Vehicle 48, 000,000 24,000,000 24,000,000 Equipment 72,000,000 7,200,000 64,800,000 88,800,000 Current Assets Stock 9, 134,000 Debtors 20,100,000 Less bad debts 600,000 19, 500,000 Add provision for Bad debtors 300,000 19,800,000 Less provision for doubtful debt 2% 0f 19,500,000 390,000 19,410,000 Add cash at hand 1,200,000 Add bank 6,800,000 27,410,000 36,544,000 Less current liabilities Creditors 16,500,000 Accrued expense Salaries unpaid 500,000 17,000,000 19,544,000 69,256,000 Financed by Loan 20,000,000 Share capital 12,000,000 Ordinary share 25% Of 12,000,000 3,000,000 Net profit 21, 134, 000 56, 134,000 Although IFRS is being used in many countries worldwide, financial statements are not yet truly comparable on a global basis. I agree with this statement that despite the use of IFRS in several counties, it has not yet been possible to compare financial statements globally. To begin with, the IFRS have kept on changing. Initially, the International Auditing Standards (IAS) was being followed but later on they were revised and changed to IFRS. This means that there is no ample time for companies within counties to fully and properly implement and follow there standards. This instability and frequent revisions mean that companies adhering to these standards do not fully benefit from them. Secondly, for there to be smooth transition within countries to IFRS, there is need for updated technology which is the key enabler (The American Institute of Certified Public Accountants 2010). This simply means that it is not possible for the financial statements to be compared since different counties have different technological advancements. There are some countries which are able to adopt IFRS easily due to their technological strength and there are others, especially the third world counties that are still behind technologically. In addition, there is a challenge within companies of transition from their previous financial statement preparation methodology to the new and most recommended one of IFRS. This transition requires some resources like the technological changes mentioned earlier. This means that any company willing to adopt this new financial statement preparation method will have to be prepared financially to achieve this. It is not all the counties of the world that have embraced the IFRS. There are some like the United States, which had continued to use their previous method of preparing these statements until recently. For the US, it had been using Generally ACCEPTED Accounting Principles (GAAP) and it is not mandatory for its companies to follow the IFRS. Instead, it’s Commission of Securities and Exchange has prepared a roadmap to be followed in the process of making the use of IFRS mandatory for its public companies. This commission recently approved 2015 to be the earliest date for any public company to be required to use the IFRS in the United States (Defelice 2010). Other countries like the Mexico announced that it would start adopting IFRS for all its listed companies in 2012 (American Institute of Certified Public Accountants 2010). This means that with the difference in adoption time of these new standards, it is hard for financial statements to be compared globally. In addition, different counties within the word experience different growth rates. Some grow faster due to developmental strength and available resources while others grow slowly. This means that putting some standards of preparing their financial statements may not work since these standards may not be applicable in all situations due to the difference in development. They may fail sometimes depending on the economical strength of the particular country. Bibliography Defelice A, & Lamoreaux, M., 2010, Journal of Accountancy, http://www.journalofaccountancy.com/ Donleavy, D, 1994, Cash Flow Accounting: International Uses and Abuses, London, Routledge. The American Institute of Certified Public Accountants, 2010, http://www.ifrs.com/Backgrounder_Worldwide.html 2009-2010 PricewaterhouseCoopers. Watts, L, and Zimmerman, L, ([1986), Positive accounting theory, New Jersey, Prentice-Hall, Inc, Englewood Cliffs. Read More