Accrual accounting is one of the two most used accounting methods. The other method is cash accounting. Accrual accounting accurately measures a company’s financial position and performance by recognizing all economic events. On the other end, cash accounting only records transactions when cash changes hands. Accrual accounting records transactions as they happen and not when a cash transaction takes place.
Accrual accounting uses the matching principle. The matching principle matches the revenues to the expenses of economic events. This method allows the current cash inflow and outflow to be combined with future transactions that are yet to take place; this gives us a more accurate picture of the financial position of the company. Now that we understand what accrual accounting is and how it works, it is time to get into the pros and cons of using this method.
Accrual accounting has many positives that can help out a business; most of these are related to expenses and revenue reporting:
Accrual accounting is a very popular method amongst all businesses because it shows a more accurate picture of the financial position of the company. It gives the business owners an idea of their accurate expenses and revenue and does not resort to counting cash transactions. Revenue and expenses are recorded as they happen; it does not allow cash transactions to ruin the balance sheet. It also helps the investors understand the true financial position of the company.
As this method records revenue and expenses as the transactions happen, it makes it easier for business owners to plan for the future. Creating plans and budgets from the data at hand allow businesses and companies to work more efficiently. It gives them an accurate picture of their inventory of goods and sales. The accrual method allows them to forecast lots of things beforehand. Hence, it is a benefit in the books of many companies and businesses.
GAAP also known as Generally Accepted Accounting Principles are rules set by the Financial Accounting Standards Board which prefer accrual accounting over cash-basis accounting. The financial statements that are prepared by the companies that use the accrual accounting method are deemed to be better than companies that use the cash accounting method, as in this method transactions are recorded as they happen rather than when cash exchanges hands.
There are not many disadvantages of using this method, but most of them revolve around the handling of the system:
Big companies and businesses have the resources and staff at hand to use this method, but the same can’t be said for a company that is operating at a smaller scale. As huge businesses can appoint a whole accounting department to prepare their statements and to keep track of transactions that occur but a small-scale business cannot afford to waste unnecessary resources. Small businesses lack the staff that is necessary to use this method accurately.
Accrual accounting is one of the most accurate methods that can be used by the business, but its accuracy comes at a price. There is a need for frequent reports. These reports are financial statements for the month, which have the income sheet and the balance sheet. Nonetheless, there is a constant need for reports on accounts receivable and payable every month.
The accrual method helps the business to record all the transactions as they happen, this may help the business in the long run but it also means that they will have to pay taxes for money that they have not yet received.
The accrual accounting method is considered better than cash-basis accounting for a multitude of reasons. However, the complexity of the method may not be for everyone. And some businesses do not have the expertise to keep track of all transactions as they take place. So, weigh the pros and cons as per the needs of the business.
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