There are two accounting methods that companies use to report revenues and expenses. The two methods are the accrual basis and cash basis. The difference in the accounting processes will fundamentally change the way the organization reports its cash, so a decision must be made prior to recording any transactions.
Accrual Basis Accounting
Accrual basis accounting is the method accepted by commercial accounting and the general accepted accounting principles. “Accrual-basis accounting means that transactions that change a company’s financial statements are recorded in the periods in which the event occur, even if the cash was not exchanged.” (Kimmel, Weygandt, & Kieso, 2009) This accounting method follows both the revenue recognition principle, by reporting the revenue when it is earned and the matching principle by reporting the expense when it is incurred. “Recording revenue before the money has come in can potentially misrepresent a firm’s financial results, allowing a company to show sales that may never actually be paid for (say, because of financial problems with the buyer).” (Cash Basis Vs. Accrual Basis Accounting, 2002) Accountants choose the accrual method of accounting over the cash basis because it more accurately represents the company’s finances.
Cash Basis Accounting
Cash basis accounting is the other method of reporting revenues and expenses. When using cash basis accounting, “companies record revenue only when cash is received. They record expense only when cash is paid.” (Kimmel, Weygandt, & Kieso, 2009) This method does not follow the revenue recognition principle or the matching principle, therefore, is not a generally accepted accounting principle for large corporations. “The IRS altered its position in 2000, allowing taxpayers who have gross receipts of $1 million or less to use the cash method (Rev. Proc. 2000-22).” (Gilmore & Miller, 2003) This change allows for small businesses to use the cash basis method, so they are only paying taxes on income received. The cash basis accounting method benefits small businesses and individuals but is not an ideal choice for large corporations.
A company must decide what accounting process is more beneficial prior to recording any transactions as this affects the way they record the information. The accrual basis method records the revenue and expenses when they occur, and the cash basis method records revenue only when cash is received and expenses only when paid. The cash reporting method tends to misrepresent an organization’s financial performance by reporting expenses prior to receiving payment for the service. The accrual basis accounting method reports financial transactions more accurately and, therefore, is the most appropriate choice for large businesses.