Differentiate between cash-basis accounting and accrual-basis accounting. Why is accrual-basis accounting the preferred method for most businesses? The Internal Revenue Service requires all companies with sales over $5,000,000 to use the accrual-basis of accounting for income tax reporting purposes. Why?
Just response each posted down below # 1 to 3
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Professor and Class,
The main difference between cash-basis and accrual-basis accounting is timing. The accrual-basis accounting method is preferred for most businesses, because when the cash-basis method is used it will cause the balance sheet to understate the revenues and expenses. The reason the IRS requires all companies with sales over $5,000,000 to use the accrual-basis of accounting for income tax reporting purposes is because it recognized the revenue when the performance obligation is satisfied and expenses in the period incurred without regard to the time of payment with cash.
Hi Professor and class,
After reading up on accrual and cash-basis accounting, I have learned about some specific differences. In accrual accounting, companies, “recognize revenue when the performance obligation is satisfied and expenses in the period incurred, without regard to the time of receipt or payment of cash”, (Kieso, D. E., et al., pg., 113). While cash-basis accounting does not meet the requirements according to GAAP standards, new or small companies can utilize the cash-basis method, with an average sales limit of $5,000,000 or less. Sales over $5,000,000 must be reported under the accrual basis method of accounting. Since transactions are accounted for, once they occur, income is logged at the time of the sale and expenses are documented when products or services are obtained, financial reports are more precise. This method is much more valuable to users, both externally and internally. Also, with accrual accounting, forecasting a business’s profitability margins can be more accurate, due to the specifics and timing of the financial entries. This is important for any business and seems to be the most appropriate way for keeping track of an organization’s finances. Cash-basis accounting is easier, but not as defined because accounts payable and accounts receivable do not appear on a balance sheet, when using this process.
The difference between the cash-basis and accrual-basis accounting is the timing of recognizing the revenue and expense transactions (Kieso, Weygant, & Warfield, 2016, p. 118). The cash-basis accounting method only records when the corresponding cash is received, or payments are made. For example, the company records the revenue when a client pays for the service fee or the company records payable transactions when paying for materials, supplies, and salaries, etc. On the other hand, the accrual-basis accounting method recognizes all revenues and expenses as incurred, does not necessarily wait until the actual cash inflows or outflows. For example, as soon as a company issues an invoice or purchases equipment on account, the accrual basis of accounting records the transactions.
The accrual basis of accounting is the preferred method for most businesses because it provides a clearer picture of when the revenues actually earned, and expenses incurred during an accounting period regardless of cash activities or not. The accrual basis of accounting gives more realistic numbers of income and expenses since it records all event transactions at the point it happened.
The IRS requires all companies with sales over $5,000,000 to use the accrual-basis accounting to report income in the year it is earned. The purpose of using the accrual method of accounting is to match income and expenses in the correct year and to report the right amount of tax.