Question

income using accrual accounting decides a firm's ability to to meet long-term obligations. Is this different if a company uses cash based accounting instead? Why or why not?

Answer 1

Businesses must choose one or the other of two possible approaches to financial reporting:

Firstly, they may select cash basis accounting. Firms using this approach record revenue when they receive cash and record expenses when the pay cash.

Secondly, they may choose accrual basis accounting instead. Firms using this approach record revenue when they earn it and record expenses when they owe them.

Cash based accouting records only two transactions i.e, Cash inflow and Cash Outflow, whereas accrual based accounting records debit and credit transactions.

Cash based accounting , firms/ companies maintain single entry system. Hence, u cannot know the whole business of company. It cannot be used for long term. The concept of matching which is core for accounting does not arise in cash basis since only two events are recorded.

It cannot meet the record keeping needs of public companies and other organizations that must file audited financial statements, such as an Income statement or Balance sheet.

Cash basis can be useful for small business with less number of transactions.

When it comes to companies or business witgh large number of transactions, accrual basis is a better method as it shows What you own and what you owe.

Hence, on the whole it can be said that Accrual system should be followed for meeting long term obligations of any business/ company.