The basis of accounting consists of two main parts. First is the cash or modified accrual basis and the other is the accrual basis. Both the cash and accrual basis of accounting are widely accepted principles within the accounting field that assist with keeping accurate notation of the income and expenses when dealing with a business. The main difference between the cash and accrual basis is the time at which revenues and expenses are reported on the income statement. (1) A specific criterion has to be followed in order to choose which accounting method should be executed. (1)
The cash basis simply identifies revenues only in the period in which cash is available and received. (1) In other words, the amount of revenue can only be recognized when cash is received in the same period as a the current liability. (1) Cash can be paid in the form of cash, check, credit card, or even an electronic transfer. (2) For instance, when dealing with the cash basis, if a product is sold to a customer on credit, a customer cannot be billed at a later date because it does not follow the criteria. (2) The same criteria applies to expenses. Expenses are only recognized when the full amount is paid in cash. (2) In this same scenario, if supplies were to be purchased on credit, it cannot be recorded until the full amount of the bill is paid. These methods is helpful because the amount of taxable income fluctuates and can often times be lower and push customers to pay debts in a different time period, resulting in the lower amount that is taxed for a business. (2) The funds that use this basis of accounting include the general fund, special revenue funds, debt service funds, capital project funds, and permanen...
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In conclusion, both methods have its pros and cons, but by understanding what each method means helps when deciding which method works best for a company. The effects of cash flow and taxes can play a major role in determining when to report revenues and expenses on the income statement. Each widely accepted principle of the accounting field helps companies when dealing with the amount of income and expenses. The businesses that want to see the amount of profitability usually lean more toward the accrual method. In contrast, businesses whose main concern tend to be the amount of cash flowing in and out of the company tend to favor the cash basis method. By keeping an accurate record of the amount of items produced, purchased, and sold, the Internal Revenue Service in accordance with GAAP requires the use of the accrual basis method for accounting procedures.
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