Define accrual accounting and contrast it with cash basis accounting

3. Define accrual accounting and contrast it with cash basis accounting.
             Accrual basis accounting is a widely used accounting method which involves updating the financial statement by simply recording the earnings and expenses as they occur. Revenues are recognized when goods and services are delivered to customers and expenses are incurred when there is a decrease in the company’s resources. Accrual basis accounting is much preferred by businesses due to its advantageous characteristics as compared to cash basis accounting. In accrual basis accounting, the expenses and earnings are recorded immediately as the transaction takes place. On the other hand, cash basis accounting monitors the cash inflow and outflow. Thus, revenues are recorded only upon the receipt of payment, while expenses are noted down only after the company pays them. A transaction is not recorded until it involves cash flow. Hence, transactions made on credit are not recorded until they are paid (Tatum, 2008).

It is easy to assess the overall financial status of the company upon utilizing accrual basis accounting (Tatum, 2008). Accrual basis accounting is more detailed and organized than that of the cash basis accounting.
4. What four conditions must normally be met for revenue to be recognized as accrual basis accounting?
            There are conditions that should be satisfied in order for the revenue to be recognized as accrual basis accounting. First, the company must be able to execute its promise. This means that cash can be received (1) in the same period as the promised acts are performed, (2) in a period before the promised acts are performed, or (3) in a period after the promised acts are performed (Phillips, Libby, & Libby, 2006).

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M3-2 Report Cash Basis versus Accrual Basis Income

Cash Basis Income Statement
Accrual Basis Income Statement
            Cash sales                   $ 6000
            Customer deposits         1000
            Inventory purchases     (1000)
            Wages paid                     (600)

Cash income                         $  4400
            Sales to customers      $ 10000

            Cost of sales                  (7000)
            Wages expense                (600)
            Utilities expense              (200)

Net income                            $   2200

PROBLEM 1-30A Interrelationships among Financial Statements
O’Shea Enterprises started the 2002 accounting period with $30,000 of assets (all cash), $18,000 of liabilities, and $4,000 of common stock. During the year, O’Shea earned cash revenues of $48,000, paid cash expenses of $32,000, and paid a cash dividend to stockholders of $2,000. O’Shea also acquired $10,000 of additional cash from the sale of common stock and paid $6,000 cash to reduce the liability owed to a bank.
a. Prepare an income statement, statement of changes in stockholders’ equity, period-end balance sheet, and statement of cash flows for the 2002 accounting period. (Hint: Determine the amount of beginning retained earnings before considering the effects of the current period events. It also might help to record all events under an accounting equation before preparing the statements.)
a. Net Income: $16,000
b. Total Assets: $48,000

Income Statement
For the Year Ended December 31, 2002

Revenue                                                                                                    $  48000
Operating Expenses                                                                                      (32000)

Net Income                                                                                               $ 16000

Statement of Changes in Stockholders’ Identity
For the Year Ended December 31, 2002

Beginning Common Stock                                    $    4000
Plus: Common Stock Issued                                     10000

Ending Common Stock                                                                             $ 14000
Beginning Retained Earnings                                                 8000
Plus: Net Income                                                       16000
Less: Dividends                                                        (2000)

Ending Retained Earnings                                                                         $  22000

Total Stockholders’ Equity                                                                        $ 36000

Balance Sheet
As of December 31, 2002
            Cash                                                           $  48000
Total Assets                                                          $  48000

Liabilities                                                                                                     12000
Stockholders’ Equity:
            Common Stock                                              14000
            Retained Earnings                                         22000
Total Stockholders’ Equity                                                                     $ 36000
Total Liabilities and Stockholders’ Equity                                                        $ 48000

Statement of Cash Flows
For the Year Ended December 31, 2002
Cash Flows from Operating Activities:
  Cash Receipts from Revenue                                $ 48000
  Cash Payments for Expenses                                  (32000)

Net Cash Flow from Operating Activities                                                   16000
Cash Flows from Financing Activities:
  Cash Receipts from Borrowing Funds                      (6000)
  Cash Receipts from Issuing Common Stock            10000
  Cash Payments for Dividends                                  (2000)
Net Cash Flow from Financing Activities                                                     2000
Net Increase in Cash                                                                                    18000
Plus Beginning Cash Balance                                                                       30000
Ending Cash Balance                                                                                $ 48000

Edmonds, T. (2006). Fundamental Financial Accounting Concepts. Boston, Mass. McGraw-Hill Irwin.
Phillips, F., Libby, B. & Libby, P. (2006). Fundamentals of Financial Accounting. Boston: McGraw-Hill/Irwin.
Tatum, M. (2008). What is Accrual Basis Accounting?. Wisegeek. Conjecture Corporation. Retrieved September 4, 2008 from

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