Question

Some people believe that cash basis accounting is better than accrual basis accounting in predicting a company's future success. This idea became more popular after many reports of corporate financial scandals where management manipulated the timing of recognizing expenses and revenues in accrual accounting to influence profit. Others argue it is easier to manipulate profit using cash basis accounting.

Instructions: Write a memo discussing the following issues:

(a) What is the difference in calculating profit using accrual basis accounting versus cash basis accounting?

(b) Identify one way that management might be able to increase profit by manipulating the timing of revenue or expense recognition under accrual accounting.

(c) Identify one way that management might be able to increase profit using cash basis accounting.

(d) Which basis do you believe is more reliable for measuring performance and why?

Answer 1

a) What is the difference in calculating profit using accrual basis accounting versus cash basis accounting?

Accrual basis and Cash Basis of Accounting are the two different types of Accounting methods to record the Accounting transactions. The difference between the Cash bais and Accrual Basis are as follows:

1) Cash Basis of Accounting records the transactions carried on cash basis. It means it records purchases when it is paid and records sales when it is received. While Accrual Basis of Accounting records the accounting transactions when it is incurred instead of when the cash involves.

2) The difference is because of the timing diifferences in recognising the expenses and revenues.

3)Cash Basis Accounting is mostly used by the smaller businesses while Accrual Basis of Accountung is used by the larger companies.

4) It is easy to maintain Cash Based Accounting as it is simple and easy to handle while the Accrual Based Accounting is complex due to the inovlvement of unearned revenue and prepaid expenses.

b) Identify one way that management might be able to increase profit by manipulating the timing of revenue or expense recognition under accrual accounting.

Under Accrual Method of Accounting one can increase the profit by manipulating the time of revenue or expense recognition suvh as recording the revenue before rendering all the services. The revenues are recorded for the current year for which a balance of services is pending in future period or shifting the the revenues incurred to the current year or current year to increase profits.

c) Identify one way that management might be able to increase profit using cash basis accounting.

Under Cash Basis of Accounting the revenue is recognised when the cash is received instead of when it is accrued. As the name suggests cash basis it records only cash related transactions and ignores the accounts receivable from customers which is a liability, if not received will be a loss to a company which is not recorded and hence shows more profit for the organisation.

d) Which basis do you believe is more reliable for measuring performance and why?

I believe Accrual method is more reliable for measuring the performance of the Company. As per the matching concept all the expenses and revenues are matched thus providing the fair statement of accounts. Most of the companies use Accrual Basis of accounting as it is required for income tax purpose and for comparing the performances with other companies also. It also provides true financial position of the company. Along with the Acrual basis of accounting Cash Flw statements are also required to know the cash flows of the business and to take relevant decision making.