Compare the relative advantages and limitations of financial statements prepared on a cash basis with those prepared on an accrual basis.

In accounting there is much to be learned, about the financial aspects of a business. In the past five weeks I have learned the importance of financial reports and how they relate to the success of an establishment. These reports may include balance sheets and income statements, which help accountants and the public grasp the overall financial condition of a company. The information in these reports is really significant to, managers, owners, employees, and investors. Managers of a business can take and deduce financial

In this paper I have defined accrual and cash basis accounting. Also, I have answered the following questions: Explain the difference between the accrual basis of accounting and the cash basis of accounting. What are the major reasons for using accrual accounting? What are the purpose of a journal and a ledger? Give an example of a contra-asset, and explain how it is recorded on the ledger as a transaction. Explain what a “prepaid expense” is and how it is recorded on the ledger as a transaction. What are the major differences in recording transactions for a for-profit organization versus a not-for-profit, or are there any? List and record each transaction

The purpose of this paper is to define accounting, and identify the four basic financial statements. The paper also explains how the different financial statements are interrelated to each other and why they are useful to managers, investors, creditors, and employees.

Financial statements provide financial decision makers with varied information presented in specific formats that is easily attainable tools to evaluate financial health. Three of the necessary financial statements are the statement of financial position or the balance sheet, operating statement also called income statement, and the statement of cash flows (Finkler, Jones, and Kovner, 2013).

Cash basis accounting gives an accurate reflection of a businesses’ cash flow. Since it only records revenue and expenses when they actually occur, the business knows how much cash it has on hand in that particular moment.

The two approaches have many aspects in common but there are two key differences that distinguish one from the other. The difference in cash accounting and accrual accounting is the way debits and credits are applied in bookkeeping. Cash based accounting recognizes income at the time it is actually received. This means that invoiced income is not counted as an asset until payment for the invoice is received. This approach is also used for debits and any expenses incurred are not posted until they are paid. Small businesses often time use the cash accounting because it is simple and easy. It is important to recognize that this type of accounting can complicate matters when the business is up for sale or a merger is offered. The type of accounting method used in any business should not be assumed.

The difference between accrual and cash basis accounting is the timing of when revenue and expenses are recognized. The cash method is most used by small businesses and for personal finances. The cash method for revenue is only used when the money is received and expenses are only used when the money is paid out. The accrual method is used for revenue when it is earned and

According to Gapenski 2008, the cash method is the process by which an economic event is recognized when a cash transaction actually takes place. It is considered simple and easy to use. Some might want to use this method when just starting a small business. Cash accounting does a good job of tracking cash flow, but does a poor job of matching revenues earned with monies laid out for expenses (Epstein, 2011). The accrual method is recognized when an obligation is created. This method is considered more complicated, yet it provides a better picture of true economic status of a business. Most would say that this is the preferred method according to generally applied accounting principles (Gapenski, 2008). It has two key components such as the revenue recognition that requires that revenues be recognized in the period in which it was earned while the matching principle requires that an organization’s expenses be matched with revenues in which it is connected to. One might want to use this principle once a small business has gotten on its feet. The accrual method does a good job of matching revenues and expenses, but it does a poor job of tracking cash (Epstein, 2011). Because you record revenue when the transaction occurs and not when you collect the cash, your income statement can look profitable even if you don 't have cash in the bank (Epstein, 2011).

From the Liberty University on-line library I was able to obtain an article called “Cash vs. Accrual Accounting” (Cantu, October 2012). This articles gives examples of cash method and accrual basis method. I was also able to find a newspaper article on “Accrual vs. Cash Method of Accounting” (Anonymous, 2011). This newspaper article defines accrual method of accounting and the cash method of accounting.

Information based on accrual accounting has historically and empirically provided a better indication of a company’s ability to generate cash flows than information gathered under the cash method. If there is not inter-period allocation, then the information is not as meaningful and will result in a mismatching of economic benefits

Financial statements are a very useful tool for individuals interested in the organization. Investors use the information to determine if it a wise decision to put their money into the organization. Investors need to determine if the organization has been successful and profitable and will continue to be successful and profitable. Creditors use the financial statements to determine the amount of credit that should be advanced to the organization. Employees generally do not look at the financial statements, but if a new executive was thinking of joining the organization, he or she may want to see the potential of the organization to make sure the investors are becoming a part of a successful organization. Management uses the financial statements on a monthly basis to determine which areas of the organization are profitable and which areas of the organization that needs to be discontinued or restructure to become more profitable.

The “financial statements are formal reports providing information on a company's financial position, cash inflows and outflows, and the results of operations” (Hermanson, p.22). There are four main components that make up a financial statement. The four parts are, balance sheet, income statements, cash flow and, statement of owner’s equity. The balance sheets role is to define the company’s assets liabilities and revenue of the business. The income statement shows the income within the company. Cash flow reviews the position of the company by cash payments and receipts. Lastly, the statement of owner’s equity shows the amount of earnings, stock and other capitals of people in the company. (Hermanson, p.34-35).

Accrual accounting is an accounting method that is utilized to size the performance and of a company by recognizing circumstances regardless of when cash transactions occur. They are documented by matching revenues to expenses at the time in which the transaction occurs rather than when a payment is processed. This method allows the current cash credits and debits to be combined with future expected cash flows to give a more accurate picture of a company 's current financial state. It is ideal to use this method of accounting if an organization has a revenue of more than five million per year. While the accrual method shows the flow of business income and debts more accurately, the downside to this method of accounting is that financial advisers may be blindsided as to what cash reserves are available, which could ultimately result in some serious cash flow obstacles. A common example that I have seen used which helps me understand is when your income ledger may show thousands of dollars in sales, while in reality your bank account is empty because your customers haven 't paid you yet. Cash Basis accounting is when revenues are documented when cash is received and expenses are recognized when paid. The cash basis of accounting is usually utilized by small companies with a revenue of less than one million annually. The cash method provides a more accurate picture of how much actual cash your business has. Cash basis accounting is allowed for tax purposes only for smaller

The major distinction between the accrual and the cash basis of accounting is when revenue and expenses are recognized. When the cash method is used, revenue is recorded when money is received. Expenses are recorded only when money is paid. The Accrual method accounts for revenue when it is earned. Expenses for goods and services are recorded when they are incurred. The

The Purpose of Financial Statements The financial statements of a business are used to provide information about the status of the business, set performance targets and impose restrictions on the managers of the firm as well as provide an easier method for financial planning. The financial statements consist of the Profit and Loss Account, Balance Sheet and the Cash Flow Statement. There are four areas of information, which we can collect from a company's financial statements. They are: Ÿ