Basis of Accounting Essay

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Accounting

The accrual basis of accounting recognizes income when it is earned and expenditures when they are incurred. This basis is used for financial statements for a couple of reasons. The first is that it is transparent, and the second is that it is consistent. For publicly-traded companies in particular, accrual accounting allows stakeholders both internal and external to benefit from the consistent production and presentation of statements, and the accrual method serves to count income and expenses when they are earned, rather than when the cash flows occur.

For most organizations, however, the accrual system is neither used nor desirable. Most organizations are small and medium-sized enterprises (SMEs), and do not need to produce financial statements for regulators. Thus, they can choose either to utilize accrual accounting or cash accounting. Most businesses find it easier and more useful to utilize cash accounting.

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Cash accounting is easier because it reflects transactions as they occur in cash. It is easier to keep track of cash flows than it is to keep track of events under accrual accounting, some of which are not even cash flows. Bank statements, for example, or simple ledgers can allow most businesses to easily track their cash inflows and outflows. These can be adapted for double-entry bookkeeping that allows for income statements and balance sheets to be produced from the sum total of the double-entry accounts (QuickMBA, 2010).

Cash accounting is more useful for small and medium-sized organizations as well. Such organizations often have tighter cash flow than larger organizations, as the latter have superior access to credit. Thus, for SMEs, it makes more sense to understand their businesses in terms of cash flows, rather than in terms….....

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