Last Updated 09 Sep 2020

Define accrual accounting and contrast it with cash basis accounting

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Define accrual accounting and contrast it with cash basis accounting.

Accrual basis accounting is a widely used accounting method which involves updating the financial statement by simply recording the earnings and expenses as they occur. Revenues are recognized when goods and services are delivered to customers and expenses are incurred when there is a decrease in the company’s resources. Accrual basis accounting is much preferred by businesses due to their advantageous characteristics as compared to cash basis accounting. In accrual basis accounting, the expenses and earnings are recorded immediately as the transaction takes place. On the other hand, cash basis accounting monitors the cash inflow and outflow. Thus, revenues are recorded only upon the receipt of payment, while expenses are noted down only after the company pays them. A transaction is not recorded until it involves cash flow. Hence, transactions made on credit are not recorded until they are paid. It is easy to assess the overall financial status of the company upon utilizing accrual basis accounting is more detailed and organized than that of the cash basis accounting.

What four conditions must normally be met for revenue to be recognized as accrual basis accounting?

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There are conditions that should be satisfied in order for the revenue to be recognized as accrual basis accounting. First, the company must be able to execute its promise. This means that cash can be received (1) in the same period as the promised acts are performed, (2) in a period before the promised acts are performed, or (3) in a period after the promised acts are performed.

Revenues
Cash sales $ 6000
Customer deposits 1000

 

Expenses:
Inventory purchases 1000
Wages paid 600
Cash income $ 4400

 

Revenues
Sales to customers $ 10000

Expenses
Cost of sales 7000
Wages expense 600
Utility expense 200

Net income $ 2200

A Interrelationships among Financial Statements

O’Shea Enterprises started the 2002 accounting period with $30,000 of assets (all cash), $18,000 of liabilities, and $4,000 of common stock. During the year, O’Shea earned cash revenues of $48,000, paid cash expenses of $32,000, and paid a cash dividend to stockholders of $2,000. O’Shea also acquired $10,000 of additional cash from the sale of common stock and paid $6,000 cash to reduce the liability owed to a bank.

Required

  • a. Prepare an income statement, statement of changes in stockholders’ equity, period-end balance sheet, and statement of cash flows for the 2002 accounting period. (Hint: Determine the amount of beginning retained earnings before considering the effects of the current period events. It also might help to record all events under an accounting equation before preparing the statements.)

CHECK FIGURES

  • a. Net Income: $16,000
  • b. Total Assets: $48,000

Reference

  1. Edmonds, T. (2006).
  2. Fundamental Financial Accounting Concepts. Boston, Mass. McGraw-Hill Irwin. Phillips, F., Libby, B. & Libby, P. (2006).
  3. Fundamentals of Financial Accounting. Boston: McGraw-Hill/Irwin. Tatum, M. (2008).
  4. http://www.wisegeek.com/what-is-accrual-basis-accounting.htm.
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