Cash Basis Vs. Accrual Accounting Essay

Tags: cash flow income statement balance sheet small business accounting risk business insurance revenue management

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Accounting

Re: Accounting Policies

The company is facing a challenge where it does not have the cash needed to pay employee salaries. Although the company shows a profit, it has negative cash flow at present. Understanding how cash accounting and accrual accounting works will highlight how this situation has come to be. Cash accounting is accounting via cash flows which is a simple methodology, typically used by small business. It is relatively easy to implement, but has a disadvantage of distorting the actual profitability of the company when the timing of cash flows are not aligned with the timing of events, something that is the case with BizCon (Accounting Tools, 2017).

The 180 financing, for example, appears as revenue on the income statement (accrual) but the cash has not yet been received. The insurance that was purchased in advance is a cash flow, but the insurance is not reported in accrual accounting as having been purchased. The cash goes down but the balance sheet shows prepaid insurance as an asset as well, so there is a slight distortion there in that the value of assets doesn\'t change, when via cash basis it would have because of the decrease in cash.

The delayed wage payments are a current liability on the balance sheet in accrual accounting, and but would not show on the income statement yet. This transaction also wouldn\'t show on cash basis either, but the reality is that it should be recorded as an expense.

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It is recommended that management looks at both cash flows and accrual accounting. There are advantages and disadvantages of both. Cash basis accounting is great for making sure that there are no cash flow problems, but it has the disadvantage of masking some of the items where the impact to the organization stretches over long periods of time, such as the 180 day credit or the 2 year insurance prepayment. In contrast, accrual accounting is accepted under GAAP, aligns items with the time period of the impact to the organization, even over multiple quarters and years. But accrual accounting has the disadvantage, especially for more vulnerable companies, of potentially portraying a significantly different picture than what the cash flows portray – management is surprised that there is a cash flow problem here, because accrual accounting does not show that on the income statement (Wilkinson, 2014).

As such, the situation that BizCon now faces is that it owes wages, but lacks the….....

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References

Investopedia (2017). Cash basis vs. accrual basis accounting. Accounting Tools. Retrieved March 11, 2018 from https://www.accountingtools.com/articles/cash-basis-vs-accrual-basis-accounting.html

Wilkinson, J. (2014) Cash accounting vs accrual accounting. The Strategic CFO. Retrieved March11, 2018 from https://strategiccfo.com/cash-accounting-vs-accrual-accounting/

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