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[The objective of financial statement is to provide information about the financial position, performance and capability of an enterprise that is useful to a wide range of users in making economic decisions.] [i] In addition, all the information provided in financial statements should be relevant, understandable, reliable and material. As a matter of fact, there are many people have an interest to know that about the ongoing activities of the business. These people are users of financial statement with accounting information. Furthermore, users can be divided into two groups, one is internal users and the other is external users.
Internal users of accounting information are managers who plan, organize, and run a business [i] . On the other side, external users of accounting information are external parties to assess the company capacity and performance. Financial statements may be used for different purposes by users, these include government entities (tax authorities), vendors, prospective investors, for external parties to assess the company's performance, owners and managers is for internal decision making and planning.
Accrual account & Cash accounting
In a nutshell, there are discussion on two large categories of accounting methods that companies tend to use, either accrual basis or cash basis, it is also presents a definition of both concepts and comparison between the two methods as well. It describes and examines the difference in managing of those methods in company and which form of accounting method is more useful and beneficial to provide information to users for different purposes.
In the first place, [under cash basis accounting, revenue is recorded only when the cash is received, and expenses are recorded only when cash is paid.] [Preparing an income statement under the cash basis of accounting is prohibited under generally accepted accounting principles] [ii] . It's totally violates the matching principles and revenue recognition. An alternative to the cash basis is the accrual basis. [Under accrual basis, accounting means that transactions that change a company's financial statement are recorded in the periods in which the events occur, rather when the company actually receives or pays cash.] [iii] There are including revenue recognition principles and the matching principles. Hence, there have different ways to record in financial statement.
Afterwards, there are using a simple example to describe accrual-based number and cash-based number. Suppose that you are the owner of the Building Engineering Company and you are accepted a new project with paint and repair a large building during year 1. In year 1 you incurred and paid the total expenses of ¿¡70,000, which includes the cost of material on paint and employees' salaries. In the meanwhile, you billed your customer ¿¡200,000 at the end of year 1, but you were not paid the expenses ¿¡70,000 until year 2. On an accrual basis, your net income would be ¿¡130,000 in year 1, and no revenue or expenses would be recorded in year 2 from this project, and the ¿¡130,000 of net income reported for year 1 can be provided an useful indication of yours' profitability and no loss would be appeared during that period. Because of the revenue recorded during the period earned in year 1, and the expenses would be matched to the period in which the revenue were earned. On the contrary, under cash basis, you would record the total expenses of ¿¡70,000 in year 1 and the revenue of ¿¡130,000 in year 2. Thus that the net income for year 1 would be a loss of ¿¡70,000, and the net income for year 2 would be ¿¡130,000. The result can be reflecting that the fact and the net cash flow in this project. Although the final result is equal, the accrual accounting reflects a more steady financial performance, and cash accounting is more fluctuated, in long term said.
Differences of accrual and cash accounting
Accrual accounting and cash accounting are two similar methods to obtaining accurate accounting records, even though there are three key differences that distinguish each method from the other. Firstly, [under accrual basis, revenues are recorded when they are earned, which may be before or after they are received, also expenses are recorded when they are incurred. In contrast, under cash basis, revenues are recorded when they are received, which may be before or IS after they are earned, expenses are recorded when they are paid as well.] [iv] Secondly, under accrual basis, [financial statements match revenues to the expenses incurred in earning them, and more accurately reflect the results of operations.] [v] On the other side, under cash basis, [it will reflect revenues and expenses based on when transactions were entered rather than when revenues were earned or expenses incurred.] [vi] iiBesides reflection of financial statement, under accrual basis, payables are recorded when payment is not made at the time of purchase and receivable is recorded when payment is not received at the point of sale. In contrast, there are no receivables and payables are recorded under cash basis. In additionally, whereas the matching principle, only under accrual basis allow you to "Let the expenses follow the revenues." [iii] Thus, the revenue recognition can be matched to the expenses incurred in earning them.
Advantages of accrual & cash accounting
Even though, there are many different ways between them. However, each one has its good points. In the first place, the cash accounting method can reduce bookkeeping costs and it is easy to use, less time-consuming as well as it can easily determine their current profitability because of cash method can provides an accurate picture of how much actual cash your business has.
In contrast, accrual accounting basis measures current income accurately and it is much easier to assess the overall financial health of the company. Besides that, it is easy to see how much revenue is due the company and simple to see what payment are outstanding. Because any outstanding expenses of company or any sales made to customers are already posted. Thus that, the current information makes it easier to predict future income and financial position.
The user's need is really important because financial statement is used to provide useful information to the users. It is sometimes argued that cash flow accounting provides better information for users than accrual accounting. Before adopt the method which needs to compare either accrual accounting or cash accounting can be more satisfies the informational needs of users'. There can be divided into two groups, one is the external users such as investors, customers, creditors and government and the other is internal users such as, employees, shareholders and management.
In the first place, there are external users of accounting information especially investors, they need more accurate future forecast of the company as well as they need to assess the profitability of the company, because of the investors hope that they can be more easily to take decisions about their investment such as deciding whether to sell, hold or buy shares, assessing the ability of the company to pay dividends and, they hope the value of their investment will increase as well. In this situation, accrual accounting can provide more accurately picture for making future forecast than cash basis accounting, also it can provide net profit pattern is more representative of the steady operating performance than cash basis accounting. After that, customers need to realize that will the business be able to supply products on a continual basis, because of the customers need to know that whether the business having going concern or not (e.g. servicing product warranties), and assess the ability of the business to deliver these products as long-term. Actually, accrual basis accounting also give a more accurate picture of profit or loss to assess what the customers want to realize in this situation. Furthermore, creditors should know that will the business seeking a loan has the ability to repay the loan debts and make interest payments. Because of the creditors or vendors either are individuals or institutions, such as insurance company or bank, who lend money to a business, thus that, they need the information to determine it. In this circumstance, creditors are more interested in entity's ability to repay them than in its profitability. Whereas 'profit' might indicate that cash is likely to be available. Originally, cash accounting is more direct with it message but it does not show the payable balance to users, therefore accrual basis accounting is more appropriate than cash basis accounting. The last users' group of external is government, who need a completeness and accuracy of the report, and compliance with accounting standard, because of government needs information to regulate these activities and they need to be aware of the commercial activities of the business to produce national statistics as well. In this case, cash accounting does not have any requirement for following accounting standards or disclosure regime of the policy, that are necessary to regulate in accrual accounting method. Eventually, accrual accounting provides better information for external users than cash accounting.
Besides that, there are internal users of accounting information especially employees, they need to assess the ability of the company to provide retirement benefits, remuneration, salaries, employment opportunities and job stability. Therefore they need to assess the stability and profitability of the company. In this situation, employees need all the information of the company by using both of two methods. Firstly, cash accounting basis can indicate the amount of cash in hand of the company, therefore the employees can more easily to assess the company's ability to pay the salaries or not. Meanwhile, accrual accounting provides net profit pattern is more representative of the steady operating performance. For management, it need to realize what decision should be made for the future, thus that they need to obtain information on the business to make their forecasts or to use in planning. In this circumstance, cash accounting can provide the sort of information such as cash budget on which decisions should be taken rather than accrual accounting; Traditional profit accounting does not help with decision-making. The last users' group of internal is shareholders who need more accurate future forecast of the company as well as they need to assess the profitability of the company, because of the shareholders want to realize whether the company have ability to pay dividends or not, and the company's going concern. In additionally, the dividends payout is depending on the company' net profit amount, if the company does not have any profit even that is losses, the company cannot payout dividends to the shareholders In this situation, accrual accounting is more useful for the prediction of net profit and dividends than cash accounting and it can provides more steady net profit amount for the company. Therefore, accrual accounting is more suitable to use than cash accounting in this part.
To sum up, accrual accounting provide better information to the users than cash accounting with the external and internal users. That's mean accrual accounting information is more suitable for most of the users and satisfies their needs. Nevertheless, it also needs to consider other factors to compare with these two methods. [In fact, cash-based accounting is very simple to use, but it is not useful, it records cash transactions only, and ignores everything else such as receivables and payables. Hence, cash basis of accounting does not provide a complete financial picture of the company. It works only for very simple businesses that never offer customers credit, never buy anything on credit to be paid later, and don't manage inventory. With cash-basis accounting there are no accounts payable, accounts receivable, and no inventory record.] [vii] Therefore, information provided under the cash method may not pass the qualitative characteristics of being relevant and reliable, as the accrual method does. Meanwhile, accrual accounting properly reflects real business performance, because this is much more widely used and accepted by businesses. For example, support you are owner of business, which is selling some mp3 music player, if you sell a product $5,000 to a business customer who pays you in 2 months later, you record the sales $5,000 at the time of delivery of the product, as sales. Since you don't have the $5,000 to pay that, hence the $5,000 owed to you is recorded as debtors or account receivable. Under accrual accounting basis, you can relies more about your real financial position rather than cash accounting, the real financial position shows how much you owe to or to owe.
Implication of preparer's adopt
Even though accrual accounting provides better information than cash accounting, there is in user's viewpoint. But in the preparer's viewpoint, there may have some limitation to concern when choosing to adopt which accounting method is more appropriate to your company. Moreover, these researches discuss five large categories of factors that Influence Company to adopt an accounting method and their implications of adoption. There are including nature of business, size of company, complexity, cost and tax. And it will be affect the financial statement presentation.
In the first place, different nature of business would be adopting different method of accounting to prepare financial statement. As the company's transaction are mostly in credit. Trading business, services and industry manufacturing company are mostly in credit; therefore, these companies should use accrual accounting. And the second factor would influence the preparers, is the size of business. It is because of the adoption of accounting method is depending on the size of business. Unanimously, small size of company would be likely to adopt the cash basis of accounting as well as their capacity is not enough or suitable to adopt the accrual basis of accounting.
Furthermore, accrual accounting method requires the reporting and the disclosure more complex than the cash accounting method. The company may consider whether or not the employee having such specified skills, for example professional accountant. If the company does not having that specified skills employee or professional accountant, accrual accounting basis would not be suitable to them, and their capacity would not enough to adopt. Thus that most large company would find the expenses and time to adopt the accrual accounting basis, hence there is well worth the effort. In contrast, small size of company may not be mostly well worth to adopt accrual accounting basis.
One of the factors the company must focus on. There should be cost, it would costly to adopt the accrual accounting basis than cash basis accounting, company adopt the accrual accounting basis is more costly than cash basis accounting. [viii] Firstly, the company may compare between the adoption cost and benefits of adoption in the future to determine whether or not adopting accrual accounting. If the cost higher than the future benefits, the company will not adopt the accrual accounting basis. The last factor is the tax. Under accrual basis accounting, if the services expense was pay in advance until the services to be completed in the next tax year, you can postpone paying tax expense until the next tax year. As the income under accrual basis, the company generally recorded when earned, the tax expense should be paid on that tax year. Expect the company receive the income in later tax year. In contrast, the income under cash basis, the company may record when receive it. And any deduction or capitalize expenses when paid. Thus that different company may adopt different method of accounting in preparer's viewpoint, even accrual accounting basis provide better information to users.
Recommend future disclosure regime
In recommend future disclosure regime, even [IAS 1 requires an entity prepare its financial statements, except for cash flow information.] [ix] But as my view, accrual accounting and cash accounting each one has its good points, which should be fully disclosure to user's to accurately determine the health of company. Thus that, each company should disclose any information which could affect the decisions made by internal and external users, that's mean each company force to prepare the cash flow statement and also disclosure. The reason of that with three, one is made fully disclosure to users to help them obtain more information such as solvency and liquidity of companies to made accurately determination. Secondly is the information is available from the cash flow statement which including cash from operating, investing and financing activities. The users can be easily identified how many cash was spending in investing, financing and operating. The last reason is It can be avoided the misleading of the financial statement, because of cash flow statement presents a detailed summary of where cash came from or paying out, but the income statement and balance sheet has not shown. For example, the financial position shows that the property, plant and equipment was increased during the year, but they do not show what happen by the additions such as sold out or bought a new one. And the financial statement does not show the amount of cash generated by operating activities, but the cash flow statement does. Thus that, the recommendation would be stated some rules to enforce the company prepare the cash flow statement and disclosed it.
As a result, stated by IASB (,) the financial statement is to provide useful information to the users either internal or external. Hence, both of the accounting methods are able to provide useful information to internal or external as well as different basis of accounting satisfied different user's needs. Under accrual accounting basis can provide wide range of information to users and their reporting and disclosure requirement must be based on IASB and the qualitative characteristic such as relevant and reliability. In fact, it can make sure that the information must be relevant and reliability, [the financial statement must pertain to the financial health of company and help investors understand what the future of company look like] [x] , and that [all information presented must be verified as reliable by an independent third party such as auditors] [xi] , thus that which can ensure that the information useful to the users and provide more accurately picture of the company performance. Even though, accrual accounting provides better information than cash accounting. But the companies also need to consider another factors such as the cost and complexity of adopt accrual accounting basis. Hence, not all the company will choose accrual accounting basis, even accrual basis provide better information to users than cash basis.
There are many reasons why I decide to continuous learning and pursue further studies. Firstly is to increase my knowledge, secondly to widen my job opportunity, thirdly for improvement of my overall personal development, and the last is less time-consuming as working what i learned. In a nutshell, I never standing at current, and always striving for the next challenge. "Practice make prefect, experience make success" I always said that to remain myself.
This module had let me learn lots of valuable skills which are improve my personal development and professional performance. There is the one valuable lesson of my college life; hence I can't let off every chance to acquiring new information or developing a new skill every day.
There have many feeling about what I am doing before, during and after my learning experience, when started working on this project before, it making me exciting and confused. The first module of this project is to argue that cash accounting provide better information than accrual accounting. When we discuss which topic is more suitable to ours on this project before, I was feeling confused, which I had several topics I wanted to choose and explore them, because of these seems like difficult to me and like a good challenge. Finally, I settled down myself and I thought it is necessary to ask my group members to discussion brainstorm and show me what they thought in choosing topic. After discussion , I realize that the most topics that I want to explore which the process must take longer than expected because I will enjoy working on that Interesting and unique topic. Besides that, we choose the simple topic to working on because it's without much difficulty, and I had so many ideas came up in my brain at that time. I have fully confidence to get well.
When we started working on this project, I find myself striving for the time mark. My lifestyle has totally become muddled as I have to work and school every day. So I felt tired every moment and always have not to complete my tasks in time frame, that the poor time management is the mainly problems of me, meanwhile we have limited time to carry out the research, how to structure of this project and I realize that this topic is not that simple of ours in fact. Apparently, this rather simple but actually this rather complicated, until now it never occurred to me. Hence we decided to use the best of our capacity and try to find the best way to make the project prefect by using our intelligent and creative and we distributed the workload surround ourselves and we need to complete in time frame by force.
Coming back to my memories, I remember very clearly during the two week process of making the individual essay and presentation, it making me very surprise, because I am able to manipulate the situation smoothly as leader although we encountered several problems about the argument between my group members and I have different viewpoints as individualistic and collective in nature. At that time, I reminded them that is necessary to overcome those problems and manipulate this situation as smoothly as we can. Hence I told that we had to understand each group member's nature, work accordingly and attitude. Finally, we are surprise that we faced the problems and handle the situation smoothly as well. As we are preparing the presentation, we have discovered that the new learning is differing from our existing learning and understanding, because it is learning deeply than our existing understand. Furthermore, we obtained lots of skills and knowledge on rare occasions, it is worthless that during two weeks.
Through this project I gained a lot of insight into accounting theory, during the project I feel I was a novice to the subject. Now that the project is over, I still feel like a novice but have better information and some experience under my belt, so that I do not feel that I am an expert on my topic any more, but I feel that I took a step in the right direction to understand the accrual and cash accounting. Besides that, it is a valuable lesson to make use of what I learnt from school to put into practice, and let me understand that to adjust according to different circumstances also applying relevant knowledge in work situation. What is more, cash accounting and accrual accounting both are always use by many company, it is very essential to know the differences of these accounting concept and apply into different business, so that to reach the final aim which is more beneficial to the company
Furthermore, I gained from making this project and writing my essay was time management in outside learning. At now I manage my time all right, but it could have been a lot better, also I believe that my essay gave me some clarification on my issue and that writhing a fifteen page report improved my writing skills. Although it was a difficult process to write the essay paper, I enjoyed the challenge very much. However, I still would like to have more knowledge and experience in accounting for becoming project in next time
Finally, this is the rarely opportunity that allows me to gained a lot of new knowledge in spite of working performance or personal development, Overall from this group's project I have learnt to think critically, to problem solving, to work in a team, interpersonal skills, communication skills, especially in working and coordinating in the team during this two week and really enjoyed the experience and also it was really informative and useful for development.