Briefly explain accrual basis of account. Also what is the reason why accrual basis of accounting is not desirable for most organizations?
An accounting system that recognizes the revenues as they are earned and records the expenses as they are incurred, is known as the accrual accounting system. Totals of expenses and revenues are included in the financial statements, whether or not the cash against these transactions is paid or received in that period. The date of receipt or payment of cash does not have any effect on the books except to record the payment or receipt of cash on that date.
Accrual accounting system is used by many firms yet most organizations find some reservations on using this system hence is not a desirable system for those organizations. The most important issue with the accrual basis of accounting is that this system requires the transactions to be recognized and recorded at the time when they occur. This issue generates quite a few problems for the business managers. First of which is the tax issue, since the revenues are shown in the financial statements, the business may have to pay tax on what it actually has not got in hand yet. The other associated problem is the inaccurate representation of cash flows in the financial statements. A business may have closed big sales in a particular accounting period, but if the customers have not made the payments, the business will have no money in its accounts for those sales. Also this system necessitates certain guesswork and estimations as the invoices may contradict the actual events which make the system harder to practice and costly on budget.
Hence the accrual basis of accounting though represents the debt and income more accurately yet it loses the track of cash flows. This results in higher tax payments and serious cash flow issues. In addition the system is comparatively more expensive and complicated to employ than the cash basis.
References
Clyde, S., Roman, W., Katherine, S., Jennifer, F. (2010). Financial Accounting: An Introduction to Concepts, Methods and Uses, Accrual Basis of Accounting, 28.
Jennifer, V.B. (n.d). The Primary Disadvantage of Accrual Accounting. . Retrieved from. http://www.ehow.com/facts_6788087_primary-disadvantage-accrual-accounting.html
Christine, L. (2010).Cash vs Accrual Accounting for Taxable Income and Expenses Retrieved from. http://www.sba.gov/community/blogs/community-blogs/small-business-cents/cash-vs-accrual-accounting-taxable-income-and-e
John, F.(2012). Advantages & Disadvantages of an Accrual Based Accounting System. Retrieved from. http://yourbusiness.azcentral.com/advantages-disadvantages-accrual-based-accounting-system-5007.html
