Paper Cash vs. Accrual Accounting - Essay Example

Only cash payments and cash receipts are recorded. The two methods are similar in the sense that their balance sheets include both liabilities and assets. The cash accounting is common among small business owners. For businesses that record annual sales of more than five million dollars or keep an inventory of items they to sell to the public, the accrual method is prescribed (Pinson, 2007). It is easier to grasp the principles of cash accounting as compared to accruals accounting. It is also cheaper to hire accountants for cash accounting as opposed to the accruals method.

In planning tax, the cash accounting is preferable by businesses because they are taxed basing on their present cash flow and not accounts receivables (Pinson, 2007). Question Two The benefit of the accrual method is that it is good at matching expenses and revenues. This method also presents a more accurate status of a company’s financial position since its financial statements are more detailed (Bragg, 2010). The balance sheets also contain more entries because they list non cash entries too.

However, the disadvantage is that it is poor at keeping track of cash. Since revenues are recorded when a business transaction takes place, the business statement will indicate that revenue is generated even without the bank account having money. The situation is more made complex by slow paying clients. The accruals method is tedious in the amount of work needed to acquire data. It also needs more resources to operate (Bragg, 2010). Conversely, the benefit of the cash accounting method is that it is good at tracking cash flow.

It is also easier to work on data and produce statements in the cash accounting. However, its disadvantage is that it is poor at matching money put out for expenses with earned revenues (Bragg, 2010). This situation poses a difficulty when a company buys items in one month and sells them in a different month. For example, a business buys an item in January intending to sell it then later pay USD 100 in cash. However, it is sold in February at USD 150 and the cash is also received in February.

At the end of January when the books were closed, the USD 100 had to be reflected, although there was no revenue to match it, hence, indicating a loss. February will, therefore, indicate USD 150 as profit, yet the true profit is USD 50. Question Three Generally accepted accounting principles (GAAP) prescribe the accruals method as opposed to the cash method because accruals method conforms to recognition of revenue, cost and match principles (Pinson, 2007). The accruals method is also practical because it captures financial implications of economic activities in the accounting periods they occur, whether cash is received or not.

Accruals method is also the method of choice for GAAP because of the accuracy of its financial reporting in complex business transactions. The accruals method acknowledges that projects and credit sales impact a business’ financial status at their time of occurrence, hence the need to reflect such transactions on the financial statements of same period within which they take place. The accruals method recognizes a sale when a client takes up ownership of a product or a service is delivered and increases the company’s revenue at that time even if cash is not yet the account (Pinson, 2007).

Question Four The United States Federal