High School Finance Teacher

Accrual vs. Cash Basis Accounting Alicia Wiley Grantham University Abstract In this paper I have defined accrual and cash basis accounting. Also, I have answered the following questions: Explain the difference between the accrual basis of accounting and the cash basis of accounting. What are the major reasons for using accrual accounting? What are the purpose of a journal and a ledger? Give an example of a contra-asset, and explain how it is recorded on the ledger as a transaction. Explain what a “prepaid expense” is and how it is recorded on the ledger as a transaction.

What are the major differences in recording transactions for a for-profit organization versus a not-for-profit, or are there any? List and record each transaction for S. Zee Outpatient Clinic under the accrual basis of accounting at December 31, 20X1, then develop a balance sheet as of December 31, 20X1, and a statement of operations for the year ended December 31, 20X1. How do capital structure rations and liquidity rations differ in providing insight into an organization’s ability to pay debt obligations?

Identify and explain two situations where an organization might have increasing activity rations but declining profitability. Explain the difference between the accrual basis of accounting and the cash basis of accounting. What are the major reasons for using accrual accounting? Cash accounting and accrual accounting are two similar methods of maintaining accurate accounting records. While the two approaches share many aspects in common, there are two key differences that distinguish each method from the other.

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Essentially, the difference between cash accounting and accrual accounting boils down to the way debits and credits are applied in the bookkeeping process. To understand the difference, it is first necessary to define each type of accounting process. Cash accounting, which is also known as cash basis accounting, allows for the recognition of income at the time it is actually received. This means that invoiced income is not counted as an asset until payment for the invoice is actually in hand. The same approach is applied to debits, in that any expenses incurred are not osted until they are paid. In contrast, accrual accounting does recognize income at the time it is earned. As goods or services are invoiced, the invoices are posted and counted as assets. They remain in this state until the face value of the invoice is credited for some reason. In like manner, any expenses are also posted at the time they are incurred or an invoice for those expenses is received, and remains open until the expenses are paid. Most mid-level and large businesses today tend to rely on the use of the accrual method rather than cash accounting.

Doing so allows a business to determine at a glance how much cash is in hand, how much is currently pending in outstanding invoices, and what current expenses are awaiting payment. What are the purpose of a journal and a ledger? The purpose of the general ledger is to record all financial transactions for a company or person and total them on a net basis (plus accounts less minus accounts) for a certain time frame according to a summary chart of accounts. The general ledger provides the important information necessary for the preparation of all basic reports required by a company or individual.

For example, the general ledger will allow the preparation of balance sheet reports and profit and loss reports for all accounting periods under review. This helps to explain why the general ledger is so important. Journal is used to record transactions in chronological order Give an example of a contra-asset, and explain how it is recorded on the ledger as a transaction? Contra-asset is an asset which, when increased, decreases the value of a related asset on the books. An example of a contra-asset is the Allowance for Doubtful Accounts, which is the contra asset to Accounts Receivable.

Contra-asset would be recorded on the balance of the debit matched up against the contra-asset credit. Explain what a “prepaid expense” is and how it is recorded on the ledger as a transaction? A prepaid expense, such as rent or insurance, is a type of current asset. It is recorded by decreasing Cash and increasing the prepaid amount by the same amount. Thus, the transaction only occurs in the Asset section of the Balance Sheet, and it is a zero-sum transaction. What are the major differences in recording transactions for a for-profit organization versus a not-for-profit, or are there any?

For-profit organization would record certain transactions under Owner’s Equity, whereas the Not-for-Profit would use Net Assets. Also, a for-profit would not show restrictions on Owners’ Equity. List and record each transaction for S. Zee Outpatient Clinic under the accrual basis of accounting at December 31, 20X1, then develop a balance sheet as of December 31, 20X1, and a statement of operations for the year ended December 31, 20X1.

How do capital structure rations and liquidity rations differ in providing insight into an organization’s ability to pay debt obligations? Liquidity is a company’s ability to meet its maturing short-term obligations. Liquidity is important for conducting business activity especially in times of adversity such as when operating losses occur due to economic conditions or drastic price increases of raw materials or parts. Liquidity ratios show a company’s ability to generate sufficient cash to meet its obligations. Liquidity must be sufficient to cushion such losses.

If not, serious financial difficulties may result. An indication of a company’s ability to meet short-term debt obligations; the higher the ratio, the more liquid the company is. Identify and explain two situations where an organization might have increasing activity rations but declining profitability. Activity rations help assess how effectively a company uses its assets. Reference Zelman, W. , McCue, M. , Millikan, A. , and Glick, N. 2009. Financial Management of Health Care Organizations: An Introduction to Fundamental Tools, Concepts, and Applications. 3e. Hoboken, NJ: Wiley & Sons.

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