Accrual VS Cash-basis Accounting By Dr. Babandi Ibrahim Gumel

The purpose of this article is to present an overview of the webinar presentation on the above topic I did to the students of LIGS University. Through non-governmental organizations, usually professional accounting associations, countries of the world develop the generally accepted accounting standards (GAAP). To better understand the GAAP, the development of the USA GAAP is presented, which will lead learners to understand the traditional assumptions of the accounting model. Within the traditional assumptions of the accounting model, the cash and accrual basis reside. During the webinar, learners were introduced to the basic financial accounting concepts such as the double-entry system and the accounting cycle to open a gate into understanding the differences of cash and accrual basis accounting. The webinar compared accrual and cash accounting with the view of understanding their effects on bookkeeping records, cash flow, and tax. The impact of accrual and cash basis accounting on cash-flow and tax was explained with an illustration for better understanding.

The generally accepted accounting principles (GAAP)

Used in the United States, was the ideal guide to ignite the debate of the importance of professional accounting bodies in developing the most critical accounting standards that will shape the regulation of professionalism. In most countries, the GAAP is supported by authorities and professional organizations: like in the US, GAAP is supported by NYSE and SEC. All the same, authorities such as SEC issues regulation S-X primarily to guide the formal disclosure of financial statements which are financial reporting releases FRR and are part of the GAAP (Alexandra, 2011). American Institute of Certified Public Accountants (AICPA) – is a professional body of professional accountants whose members are certified public accountants (CPA). When pressure builds of developing GAAP in 1972, a special study group of the AICPA established the financial accounting standards board (FASB). Financial Accounting Standards Board (FASB) – its structure includes a panel of electors who are selected from nine professional finance and accounting bodies (Accounting Standards Committee American Accounting Association's Financial, 2007).?The electors appoint the board trustees that govern the Financial Accounting Foundation (FAF).?The FAF appoints the Financial Accounting Standards Advisory Council (FASAC) and the FASB. The FASB issues four types of pronouncements as follows: 1. Statement of Financial Accounting Standards (SFAS) – meant for GAAP of specific accounting issues, 2. Interpretations – are pronouncements for clarifications of previously issued accounting standards, 3—technical Bulletins – aimed at providing timely guidance on financial accounting and reporting problems, and 4. Statements of Financial Accounting Concepts (SFACs) – provides a theoretical foundation on which to base GAAP; are the output of a conceptual framework but not part of GAAP?(Glen, 2007).?

Some underlying assumptions influenced the conceptual framework of FASB. FASB's framework addressed some of the assumptions while others are implicit in the framework. The framework and assumptions are considered when establishing GAAP. Accountants resolve situations lacking standards by considering the conceptual framework and the traditional assumptions of the accounting model, including Business Entity, Going concerned, time period, monetary unit, historical cost, conservatism concept, realization, point of sale, matching concept, consistency, full disclosure, materiality, industry practice. Transaction approach, cash basis, and accrual basis (Ge, W. & Sarah, M., 2005). The webinar discussed the cash and accrual basis of accounting with illustrations of their implications.

The accounting cycle

Is the sequence of accounting procedures completed within an accounting period. There are three broad summary steps of the accounting cycle: recording transactions, recording adjusting entries, and preparing the financial statements?(Geiger, M. A. & Raghunandan, K., 2002).

Recording Transactions

As events of transactions happen, they change the firm's assets, liabilities, or stockholders' equity; thus, changing the firm's financial position. There are two types of transactions, internal and external transactions. While internal transactions are confined within the company, external transactions happen outside the company. Transactions are recorded in a book of original entries called the journal, mostly a general journal. Also, firms use special journals to record most transactions. Special journals are designed to improve special keeping that is not possible with a general journal. Transaction recorded in a journal is called journal entry. Journal entries are later posted into the general ledger (a group of accounts of a firm) as summarized information by account. Accounts store monetary information from recording transactions, examples, land, cash, and buildings. The T-account system is a logical format and can be computerized or manual. The double entry system has been in use to record transactions, with each transaction recorded with an equal number of debits and an equal amount of credits. The double entry system revolves around the equation: Assets = Liabilities + Stockholders' Equity. And debits mean the left side of the T system, and credits mean the right side of the T system.

Recording Adjusting Entries

There is a distinction between accrual and cash basis of accounting. ?Accrual basis accounting requires that revenue be recognized when realized (Realization concept) and expenses recognized when incurred (matching concept). ?The point of cash receipt for revenue and cash disbursement for expenses is not important on an accrual basis when determining income. However, accrual basis must be used by firms to achieve reasonable results for the income statement and balance sheet. The accrual basis requires numerous adjustments to account balances at the end of the accounting period. Adjusting entries are recorded in the general journal and then posted to the general ledger. Once accounts are adjusted to the accrual basis, the financial basis can be prepared.

Preparing the Financial Statements

The accountants use the accounts after adjustments have been effected to prepare the financial statements. These statements represent the output of the accounting system. The balance sheet and the income statement can be prepared directly from the adjusted accounts. However, the preparation of the statement of cash flows requires further analysis of the adjusted accounts.

The difference between cash and accrual

The difference between cash and accrual accounting lies: In the timing of when sales and purchases are recorded in your accounts (McCool, C., 2019). Cash accounting recognizes revenue and expenses only when money changes hands. Accrual accounting recognizes revenue when it's earned and expenses when they're billed (but not paid).

Cash basis accounting

The cash basis of accounting recognizes revenues when cash is received and expenses when they are paid. The method does not recognize accounts payable and account receivables. Many small businesses use the cash basis of accounting because it is simple to maintain. It is also easy to determine when a transaction has occurred, and there is no need to track receivables or payables (McCool, C., 2019).

Accrual basis accounting

Accrual accounting is a method of accounting where revenues and expenses are recorded when they are earned, regardless of when the money is received or paid. The upside is that the accrual basis gives a more realistic idea of income and expenses during a period, therefore providing a long-term picture of the business that cash accounting can't provide?(Gibson, 2013). The downside is that accrual accounting doesn't give any awareness of cash flow; a business can appear to be very profitable while it has empty bank accounts. ?Accrual basis accounting without careful monitoring of cash flow can have potentially devastating consequences.

References

McCool, C. (2019). Cash Basis Accounting vs. Accrual Accounting. Bench, Retrieved August 10, 2020, from https://bench.co/blog/accounting/cash-vs-accrual-accounting/

Alexandra, D. (2011). Private company financial reporting. Journal of Accounting, 34-36.

American Accounting Association's Financial Accounting Standards Committee. (2007).

The FASB's conceptual framework for financial reporting: ?A critical analysis. Accounting Horizons, 229-238.

Ge, W. & Sarah, M. (2005). The disclosure of material weaknesses internal control after the Sarbanes-Oxley act. Accounting Horizons, 137-158.

Geiger, M. A. & Raghunandan, K. (2002). Going-concern opinions in the new legal environment. Accounting Horizons, 17-26.

Gibson, C. H. (2013). Financial Statement Analysis. Delhi: Cengage Learning India Private Limited.

Glen, C. (2007). If IFRS offers the answer, they sure raise a lot of questions. Financial Executive, 21-23.

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