Question

Discuss the accounting policy implications of the cash basis and accrual basis of accounting and justify which of the basis of accounting you will recommend for application in the preparation of financial statements in the public sector

Answer 1

The cash basis of accounting recognizes revenues when cash is received, and expenses when they are paid. This method does not recognize accounts receivable or accounts payable.

Many small businesses opt to use the cash basis of accounting because it is simple to maintain. It’s easy to determine when a transaction has occurred (the money is in the bank or out of the bank) and there is no need to track receivables or payables.

Accrual accounting is a method of accounting where revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid. For example, you would record revenue when a project is complete, rather than when you get paid. This method is more commonly used than the cash method.

The upside is that the accrual basis gives a more realistic idea of income and expenses during a period of time, therefore providing a long-term picture of the business that cash accounting can’t provide.

The cash-basis and accrual-basis are two different approaches that bookkeepers can use to record the financial transactions of a business.

Generally, small businesses, not-for-profit organisations, some Government agencies and community associations use the cash-basis while larger for-profit businesses use the accrual-basis. This is because the cash-basis is quite simple to understand and maintain while the more complicated accrual-basis produces the more accurate assessment of the financial position and performance of the business. Tax laws and accounting standards generally give small organisations a choice as to which approach they will adopt. At the same time larger organisations and public companies are required to record their financial transactions using ONLY the accrual method.