Paper Example on Accounting Methods

Introduction

The main accounting methods that most companies use when preparing the books of accounts include cash basis and accrual basis. These two accounting methods are different from one another despite the fact that both can be used at the same time (Szychta, 2002). The difference in these accounting methods depends on the timing of revenue and expenses recognition. In cash basis revenue and expenses are recognized immediately and accrual method revenue and expenses are recognized at a future date. For BizCon to encourage its clients to hire its services, it offers 180-day financing meaning that the customers are required to pay for the services after 6 months. In this case, BizCon uses the accrual basis of accounting where revenues are recognized at the time they are earned but not when cash is received from the customer. It, therefore, means that BizCon will enter revenue from the client immediately it offers service (Szychta, 2002). When cash basis is used, the revenue from the client will be recognized after 6 months when the customer shall have paid cash to the company or BizCon for the services it received 6 months ago (Farshadfar & Monem, 2013). This clearly shows that cash basis recognizes revenues when cash is received while accounting basis recognizes revenues when it is earned.

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Because BizCon is a new company, the suppliers want to receive payment on cash delivery. When cash is paid on delivery by the company to suppliers, it, therefore, means that the company uses cash basis which requires the company to recognize expenses when cash is paid. In this case, BizCon cannot use the accrual basis of accounting which recognizes expenses when earned but not when cash is received (Szychta, 2002). The difference between cash basis and accrual basis arise on the timing of cash. When a business transactions are entered in accounting records at the time cash is paid for expenses such as for equipment then cash basis accounting is used but when the transaction is entered into the accounting books before cash is received but a business transaction occurred, accrual basis of accounting is applied (Farshadfar & Monem, 2013). In accrual accounting method expenses corresponds with similar revenues and can only be reported at the time of the occurrence of expenditure but not at the time when the company makes payment for an expense.

When BizCon had to pay up front for two years of insurance, the company will not record the whole amount paid for two years but will only enter insurance expenses for one year in the income statement. The balance will be reported on the balance sheet as an asset when accrual accounting is applied. It will only be reported in the income statement in the second year as an expense although cash has been paid. At the same time when BizCon has not paid employees for one full month of salary at the end of the year because of cash shortage and pledged to pay in the first week of next year (Szychta, 2002). This transaction can be reported using both cash and accrual accounting basis. In cash basis, the payment of salaries will be reported in the financial statement of the following year while in accrual basis, it will be entered in the income statement of the current year in which the expense is earned. Employee salary will be shown on the financial statement as an expense while in cash basis there will be no transaction as employee salary in the income statement. In the balance sheet it will be reported as a liability when accrual accounting method is used but on a cash basis, it will be reported as an expense in the following year.

Conclusion

It is possible for the management of BizCon to have positive net income but run out of cash at the end of one financial year. This is possible when it uses accrual accounting method which recognizes revenue when earned but not when cash is received (Farshadfar & Monem, 2013). The company can have a very long credit period say 180 days to receive its credits. It will record all its revenues in the income statement before receiving cash from trade creditors. This will increase its sales revenues before cash is received at the end of the financial year.

References

Farshadfar, S., & Monem, R. (2013). Further Evidence on the Usefulness of Direct Method Cash Flow Components for Forecasting Future Cash Flows. The International Journal of Accounting, 48(1), 111-133. doi:10.1016/j.intacc.2012.12.001

Szychta, A. (2002). The scope of application of management accounting methods in Polish enterprises. Management Accounting Research, 13(4), 401-418. doi:10.1006/mare.2002.0198