Question

Imagine that you opened a restaurant in your hometown and you decided to take the knowledge and skills you learned in this class and be your own accountant. Discuss whether you would prefer to keep your accounting records on the cash basis or the accrual basis. As part of the discussion, explain how and why you selected one basis over the other.

Answer 1

In accounting there are two principal methods of tracking the organization’s income and expenses. These accounting methods are cash method and the accrual method (sometimes called cash basis and accrual basis, respectively). Generally, speaking an organization can select the accounting method that best serves its needs.
These methods differ only in the timing of the transactions, including sales and purchases, are credited or debited to the appropriate accounts.
In the cash method income is not counted until the cash is actually received, and expenses are not counted until they are actually paid.

In the accrual method the transactions are counted when the order is made, the item is delivered, or the services occur regardless of when the cash for them (receivables) is actually paid. In other words, income is counted when the sale occurs, and expenses are counted when receipt of the goods or services. The recording of the business transaction and the actually receipt of payment processes are independent of one another.

Income is recorded upon completion of the service or deliver of all the goods associated with that order. Similarly, expenses are recorded upon completion of the service or receipt of all the goods. In some instances the expenses are recorded upon receipt of all goods and installation of them.

The accrual method clearly illustrates the ebb and flow of the organization’s income and expenses more accurately than the cash method. However, the accrual method does not provide visibility to cash reserves and flow. For instance the organization’s income statement may demonstrate a positive sales position and cash reserves and flow could be suffering due to poor collections.

The cash method provides a more accurate picture of the organization’s actual cash position, however it can provide a misleading picture of longer-term profitability. The cash method accounting can demonstrate one month to be spectacularly profitable based on payments received from credit customers in that same month when actually sales have decreased in that same period.
To have a firm and true understanding of your business's finances, you need more than just a collection of monthly totals; you need to understand what your numbers mean and how to use them to answer specific financial questions.

In order to make an informed decision, more information is required than just the collection of monthly financial totals. There are IRS regulations governing both of these methodologies. The cash method is the more commonly used method of accounting in small business when sales are less than $5 million. The accrual method of accounting is required if the organization’s sales exceeds more than $5 million or stocks an inventory of items that are sold to the public and gross receipts are over $1 million per year. Inventory includes any merchandise sold, as well as supplies that will physically become part of the end item intended for sale.

So i would prefer to use accrual basis of accounting to present a true and fair picture of my accounts and also make my accounts comparable intra firm and inter firm , also it resolves the hassel to maintain two types of books if in a country you keep books on cash basis but the tax laws want you to maintain the books of accounts on accrual basis

You can elaborate on any point you like