Throughout this course we have been using the accrual basis of accounting to com

Question

Throughout this course we have been using the accrual basis of accounting to complete our work. However, there are two other methods of accounting, the cash and the modified cash bases.

For this assignment please answer each of the following questions in a short paragraph:

Explain the accrual, cash, and modified cash bases of accounting.

Compare the methods and demonstrate the similarities, differences, advantages, and disadvantages of each method.

Which method seems easiest to work with? Keep in mind not only the ease of recording the transactions but the ease with which the accountant can use the resulting financial information.

Which method(s) are approved by GAAP?

Explanation / Answer

Accrual basis is a method of recording accounting transactions for revenue when earned and expenses when incurred. The accrual basis requires the use of allowances for sales returns, bad debts, and inventory obsolescence, which are in advance of such items actually occurring. An example of accrual basis accounting is to record revenue as soon as the related invoice is issued to the customer.

A key advantage of the accrual basis is that it matches revenues with related expenses, so that the complete impact of a business transaction can be seen within a single reporting period.

The cash basis is a method of recording accounting transactions for revenue and expenses only when the corresponding cash is received or payments are made. Thus, you record revenue only when a customer pays for a billed product or service, and you record a payable only when it is paid by the company. Many small business owners may be using the cash basis without even realizing it, if they are recording business transactions primarily with a check book.

Cash basis accounting is allowed for tax purposes only for smaller entities, and is not acceptable under generally accepted accounting principles or international financial reporting standards. The cash basis is useful under the following circumstances:

The cash method can yield inaccurate results, because revenues may be recognized in a different period than the period in which related expenses are recognized. The result can be incorrectly high or low reported profits.

See the Cash Method article for more information about the cash basis from the taxation perspective.

The modified cash basis of accounting uses elements of both the cash basis and accrual basis of accounting. Under the cash basis, you recognize a transaction when there is either incoming cash or outgoing cash; thus, the receipt of cash from a customer triggers the recordation of revenue, while the payment of a supplier triggers the recordation of an asset or expense. Under the accrual basis, you record revenue when it is earned and expenses when they are incurred, irrespective of any changes in cash.

The modified cash basis establishes a position part way between the cash and accrual methods. The modified basis has the following features:

The modified cash basis uses double entry accounting, so the resulting transactions can be used to construct a complete set of financial statements. It is not possible to have a modified cash basis of accounting using only the single entry system.

The modified cash basis is not allowed under Generally Accepted Accounting Principles (GAAP)

Only Accrual basis of accounting is approved by GAAP.

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