Question

Discuss and analyze alternative perspectives for determining financial performance. Out of three methods (Cash flows reporting, Accrual accounting, Tax reporting), which one do you prefer, why?

Answer 1

Cash Flow Reporting

In cash flow reporting, income is identified only when cash is received and expenses are recognized only when payment is made. The books are maintained only on the basis of a real flow of cash into and out of a business.

It is easy and less expensive. It does not recognize accounts receivable and accounts payable. Small businesses use cash flow reporting. It helps to determine how much cash a business actually has. It can be used to delay the recognition of taxable income.

Accrual Accounting

In accrual accounting, revenue and expenses are recorded when earned regardless of when the money is actually received or paid. It provides a more realistic picture of income and expenses during a period.

It is the normal approach of recording business transactions. It is supported by the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

Tax Reporting

Tax reporting can be done using cash flow reporting method or accrual accounting. Individuals tend to use the cash flow method while businesses use accrual accounting.

While preparing tax returns using the cash flow method, only earnings one receives in payments during the tax year are included in gross income. In accrual accounting, taxpayers report income in the tax year for which they have a legal right to receive. You can deduct expenses before payment in accrual accounting.

Accrual accounting is more useful than cash reporting. It provides a true picture of the performance of a company during a period since revenue and expenses are recorded when cash is actually paid and received. It precisely records the value of a company’s assets, equity and properties.

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