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 statement in the public sector.

Answer 1

Accrual basis of accounting is the most commonly used method of accounting which involves recording revenues and expenses as they incur even if actual cash transactions are supposed to take place in a later date.
Cash basis is an accounting system where revenues are recorded when there is actual cash collections. Similarly, expenses are recorded when there is an actual outflow of cash. Cash basis is simpler as compared to Accrual basis which gives a true cash balance that the company has asd it does not involve Accounts receivable as well as Accounts payable.

For preparation of financial statement in the Public sector, Accrual Basis of accounting is recommended because unlike cash basis when revenues are recorded only on actual cash receipts, Accrual basis smooths out earnings over time by recording them as they incur. From investor's point of view in case of cash basis, even if a company has made huge credit sales and is doing well still no revenues will be recorded until actual receipts takes place which will display the company as not doing well even though in reality it is profitable. The accrual basis of accounting gives a more realistic idea of incomes and expenses of the company over a period of time as compared to cash basis. Though it is true that accrual accounting also has its demerits such as showing business to be profitable as a result of huge receivables even when there is lack of cash balances, still for a public sector company it is important to depict the true functioning of company in the long run which is done by accrual basis as it considers all revenues and expenses as they incur and not wait for date of actual cash transaction to take place before they are recorded.

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