Thursday, September 18, 2014

Cash Vs Accrual



Understanding Cash and accrual basis of accounting is very important to know overall implication of financial accounting on financing and investing decision. Preparation of cash flow statement requires total understanding of cash vs. accrual system of accounting. Cash flow is the starting point to analyse the viability of the project/organisation. International financial standard requires transactions to record in accrual basis of accounting. i.e. IAS 1 requires that an entity prepare its financial statements, except for cash flow information, using the accrual basis of accounting.

Under cash basis a transaction is complete and is only recorded when cash is received or paid. Open transaction is not recorded until it is closed by the delivery of cash and cash equivalent. Eg. a prepaid expense (recognised as assets on accrual basis) will be recorded as expense on the date the cash is paid. Likewise, checks are written when funds are available to pay bills, and the expense is recorded as of the check date - regardless of when the expense was incurred.

Accrual basis accounting matches revenues and expenses to the time-period in which they are earned and incurred. It captures true picture of all transactions that takes place within given time-period. Example; vendor record shows all bills paid, credits, and payments for that vendor and A/P Aging Summary and A/P Aging Detail reports show outstanding (unpaid) bills. This is a good report to use to prioritize payments and manage cash flow. The Profit and Loss report will show all bills — whether the bill has been paid or not — on the accrual basis, and only paid bills on the cash basis. The balance sheet will show the vendor liabilities (unpaid bills) in the accounts payable account.

The same is with most of expenses and revenue items. Eg. Accounts like wage, tax and purchase can take form of assets if paid in advance, a form of liability until it is paid and is expensed when paid. Accounts like interest income and sale can take form of assets until received and a form of liability if received in advance and is recognised as revenue when amount is received.  Understanding this nature is vital for the preparation of cash flow statement using indirect method.

Alternatively, by straightforward recording of transaction on cash basis we can prepare cash flow by using direct method.



http://office.microsoft.com/en-us/support/understanding-cash-and-accrual-basis-accounting-HA010164612.aspx

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