Question

Think about the implication for a business if they didn't record adjustments and followed cash basis accounting while everyone else in their industry followed the rules of accrual based accounting. Using no less than 100 words, identify one disadvantage of following this method of accounting.

Answer 1

Cash basis of accounting might be an easier way of accounting because we will be recording only transactions which occur through actual and do not record transaction which might have occurred on a credit basis or nominal basis. When no such transaction is recorded - it always leads to incomplete record and incomplete picture of the business transactions and creates problem in assessing depth and width of the business in its volume and quality.

It doesn't show business liabilities for creditors, deferred revenue or any other transaction where payment might not yet have occurred.

Also, as mentioned in the question, the industry as a whole follows accrual basis of accounting whereas the company follows cash basis – it will create problems while comparing company’s performance with respect to other companies in the industry.

Thus, we can conclude that cash basis of accounting creates a myopic view of business transactions and also makes it hard for the businesses to compare their performance with other industry players where difference in their accounting systems exist.

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