Financial Statement

Summary Question One

Introduction

There are two types of accounting methods for recognizing financial transactions. They are accrual and cash basis accounting. Accountants use these methods in accordance with Generally Accepted Accounting Principles (GAAP), which have rules established by various professional and regulatory boards. These two methods are the basis of accounting upon which financial statements are built ("How to Use Financial Statements," 2011). This paper will describe both basis of accounting and explain the differences.

Accrual Basis Accounting

Accrual basis accounting is a method used to record financial transactions in which events occur regardless of inflow or outflow of cash. When a company uses accrual basis accounting, it records revenues when services are provided or goods exported not when services and goods are paid for to the company. Basically, the company recognizes revenues when earned, even if cash was not received and expenses when they acknowledge they will have pay out (Cudia, 2008).

Cash Basis Accounting

Cash basis accounting can be used as an alternate to accrual basis accounting. Cash basis accounting records financial transactions when cash is received not earned. For cash basis accounting, company records revenue when cash payments are made for goods received or services performed (Barton, 2005). Cash basis accounting is a useful a tool when there are complications with revenues at the time of services is provided or goods exported because payout is uncertain.

Explanation of Differences

Accrual and cash basis accounting are based on the same underlying activities. However, the differences arise from the timing of when financial transactions of costs are recognized. Accrual basis accounting is more consistent and GAAP requires this use of this method ("How to Use Financial Statements," 2011). It follows the principle of matching income with expenses by capturing accurate transactions of expenses in the period when revenue is earned. This gives a company a true picture of its financial standing allowing a better decision-making tool. However, accrual basis accounting does not accurately reflect the company's amount of available cash (Cudia, 2008).

Cash basis accounting has the advantage of simplicity and can be substantiated quickly. "However, non-cash accounts such as receivables and payables arising from the ordinary course of the business are not recorded" (Cudia, 2008, p 13). A company may use this method without violating GAAP if any amount is insignificant. Neither does it match expenses with revenues and does not provide an accurate financial picture. Cash basis accounting information is not relevant and reliable and can lead to poor financial