Whiledealing with financial recording, it is essential to have a fullunderstanding of two primary methods of tracking expenses andbusiness income. These include accrual basis and cash approach (Stice& Stice, 2013). The major difference between the two methodsoriginates from the timing of when purchases and sales are debited orcredited to a company’s accounts. When using the cash basis, incomeis recognized when it is received, and expenses are counted when theyare paid. However, under the accrual basis, transactions arerecognized once they occur, regardless of the time cash is paid orreceived. Various publicly traded companies and business lines differin the way revenue should be recognized.
Accordingto the revenue recognition principle, revenue should be booked whenit is realized and when it is earned or at the time of sale. Thismeans that organizations should not wait until they receive therevenue for it to be recorded in the books of accounts. One of themajor advantages of using accrual basis is that the accountingrecords provide a fair image of the company’s profits for aparticular accounting period (Stice & Stice, 2013). This is basedon the fact that, by using an accrual basis, the income statementprepared during the accounting period clearly depicts the revenuethat is earned and expenses incurred to earn the revenue.Alternatively,the accrual basis indicates a fair picture of a company’s financialsituation at a point in time. Companies using accrual basis are ableto record all assets earned as well as liabilities incurred promptlyon time.
Ibelieve that accrual method is a proper accounting system. Thismethod is the best approach since it provides shareholders withcandid information regarding the income and expenses of a company.For companies that invoice work done, the matching amounts arerecorded in the books of accounts even if the firms have not receivedany payment. Similarly, all debts are shown in the books and thedates they were incurred despite that they will be paid in future.Using accrual accounting system, a company is able to make effectivemonitoring and financial management activities. This is based on thefact that organizations can easily identify the amount of money theyare earning and then make reports on future expenses. This methodalso enhances accuracy. Accrual accounting system provides truefinancial responsibilities and resources of a company. In this way,an organization is able to make an accurate assessment of debts andincome.
Consequencesof Not Following the Accrual Accounting System
Intheir efforts to comply with generally accepted accounting principles(GAAP), businesses use accrual accounting with the objective ofshowing the financial position of the company at any given time. Ascompared to the cash basis, the accrual basis is more reliable. Thus,there are consequences of not following the accrual accounting systemwhich companies should make efforts to avoid.
First,if the system is not followed, the financial information of a companywill not be very accurate. Projects that generate streams of revenueand selling on credit are key aspects that have impacts on thefinancial position of a company (Stice & Stice, 2013). This meansthat to have more accurate information, transactions should beindicated in the financial records and be reported at the same timethey occur.
Second,failure to apply the accrual accounting system can also result in alack of clear monitoring of cash flow. Using the cash method, abusiness can appear to have very high profits, but in reality, thebank accounts are empty. Lack of proper cash flow monitoring caneasily result in liquidity problems in a company. Lack of matchingthe revenue and expenses incurred to generate the revenue can make acompany’s financial reports to indicate very high profits or lossesfor certain products or services (Stice & Stice, 2013). In thisway, company management may not be aware of the actual costs andrevenue generated by a particular business unit.
Oneof the main communication strategies that I recommend to be used toensure the system is followed is one-to-one meetings. This impliesthat senior accountants must engage all the accounting personnel anddiscuss the significance of using the approach besides identifyingways of determining the revenue and company expenses. Through suchmeetings, accounting officers will get opportunities to ask questionson any issue that is not clear to them as far as the recording oftransactions is concerned. Training programs will also provide ampleopportunity for accounting employees to learn about the system’snew standards and exemptions. As GAAP continues to make accountingchanges, new recording regulations are emerging. It is throughtraining that accounting personnel can be exposed to such standards.
Thediscussion clearly shows that as compared to the cash basis, theaccrual basis is a better accounting system. First, it makescompanies provide a fair image of their financial position byrecognizing the revenue once earned and expenses immediately they areincurred. Organizations that fail to apply accrual accountingstandards as specified by GAAP may not effectively monitor cashflows, which may make them provide inaccurate financial reports. Thisimplies that there is a need to maintain clear communication systemsthat expose accountants to emerging recording rules that comply withGAAP.
Stice,J. D., & Stice, E. K. (2013). Intermediateaccounting.Mason, OH: South-Western Cengage Learning.