In: Accounting
If the cash basis and cash basis financial statements are not in accordance with GAAP, why are they allowed?
Solution:
Note: The solution is provided in question-answer formate in order to develop a better understanding.
What is cash basis accounting?
An accounting method that recognizes revenues and expenses at the time cash is received or paid out. Credit transaction is not recorded till amount is received or paid.
Does Cash Basis accounting violate GAAP?
The answer is Yes, because it violates the matching principle, time period principle, and doesn’t reflect the actual company performance or financial status.
Then Why Cash Basis accounting is allowed and used?
Because:
1. Easy and Simple to use the method for small business. Does not need specialized knowledge of accounting.
2. Small Business does not have sufficient resources to implement double entry systems and prepare all set of books.
3. The company operates as a sole proprietorship. Does not need to publish a financial statement like listed companies
4. Sell or Buy transaction is carried out on a cash basis and not on a credit basis
5. The business has few financial transactions
6. The business have no Inventory to track or value.
Note:
1. GAAP is not law and is only required for companies that are publicly traded. The small, private companies use the cash basis method because of its simplicity.