Cash and accrual accounting - Essay Example

Meanwhile, accrual basis is accounting techniques that transactions are recognized when item is delivered, and revenues are recorded when they are earned. Although, the two methods are both accounting method and used to record transactions, they are different in various ways and the paper will evaluate the difference of the two accounting methods used to recognize transactions. Cash vs. accrual accounting Accrual-basis financial statements give more practical information than cash-basis statements because the accrual-basis is a method that is recognized by the generally accepted accounting principles (GAAP).

However, the cash basis statement is not useful as accrual basis because it is not recognized by the GAAP. Meanwhile, the accrual basis ensures firms have recorded transaction in the period that the event has occurred. For instance, to establish the net income it will require the company to recognize revenue when it was earned but not when it received the cash. Meanwhile, the company under the accrual basis will recognize the expenses at the period when they are incurred and not the period when they are paid.

Conversely, the companies that use cash basis accounting can record revenues when they get cash, and record an expense when they pay out cash. Although, cash basis seems appealing because of its simplicity, it frequently generates false financial statements (Diamond, 2006). Meanwhile, cash basis fails to record revenue that the company has earned and instead opt to record revenue that it has received the cash. Meanwhile, the accrual basis matches expenses with earned revenues, but cash basis does not match the expenses with earned revenues.

Cash basis is recommendable for the small firms because they do not prepare detailed receivables and payables, but accrual basis accounting is mostly utilized by large businesses. Conversely, companies that use the accrual method to make adjustment entries for accruals will record revenue earned in the recent accounting period (Diamond, 2006). Adjusting entries under an accrual method maintains two purposes that include showing the receivables. This exists in the balance sheet and involves recording the revenues earned during the period.

Meanwhile, before the adjustment is done under the accrual method, assets and revenues are understated. Under the cash method, before the adjustment entries are performed for the prepaid expenses, assets are overstated, and expenses are understated. Moreover, many small businesses use the cash method for recognizing transaction because it offers flexibility in managing taxable income used in the running of the business. In contrast to cash basis methods, accrual methods will record transactions that are made, and most of the companies use the method (Biafore, 2010).

The accrual method offers better matching between revenues and their related cost that assist firms understand the true causes and effects of various business activities. Consequently, revenues are recognized during the same period in which sales transactions occurred, and expenses are recognized in the same period as their linked revenues. However, the two accounting methods are used to recognize the transactions