Question

You are a new accountant at a salon. The salon had previously used cash basis accounting to prepare its
financial records but now considers switching to an accrual basis method. You have been tasked with
determining if this transition is appropriate.
When you go through the records you notice that this transition will greatly impact how the salon reports
revenues and expenses. The salon will now report some revenues and expenses before it receives or
pays cash.
How will change positively impact its business reporting? How will it negatively impact its business
reporting? If you were the accountant, would you recommend the salon transition from cash basis to
accrual basis?

Answer 1

What is cash basis of accounting?

cash basis of accounting is simple as this method records revenues and expenses only when cash is received or paid rather than when they are incurred .this method helps to know how much cash is available to the company and dont have to pay taxes on income untill it is received.but cash accounting method can misrepresent company's financial position.when using cash accounting , financial reports do not represent the true/complete financial position and performance of the business . this method does not comply with the accounting concept of the matching principle .matching principle requires that expenses should be recorded in the financial statements in the accounting period in which the revenue , to which those expense relate is earned .cash basis of accounting does not comply with GAAP (Generally Accepted Accounting Principles) .financial institutions may not accept this accounting method when making loan applications.

Accrual basis of accounting and its positive and negative impacts on business reporting:

accrual basis of accounting records revenue and expenses when they are incurred rather than when they are or received paid .it follows the matching principle of accounting .accrual basis of accounting has lot more benefits than cash basis of accounting .as expenses and revenue are recognised when they are incurred it shows an accurate picture of profit or loss for a particular period and the true and complete financial position of the business.this method complies with tax law and GAAP .when following accrual method , financial reports have more credibility with financial institutions and investors . accrual basis of accounting is a reliable financial analysis and decision making tool and it enables industry benchmark comparisons which helps to evaluate the growth of the company .

when switching to accrual basis of accounting from cash basis of accounting , company may have to face some additional costs. accrual basis is lot more complicated than cash basis of accounting because it requires to record more transactions under the same financial events. receivables accounts and payables accounts will have to be recorded as the salon will have greater impact on its revenue and expenses when switching to accrual basis of accounting.this may cost additional expenses to the company for the accountant as he have to prepare the financial statements according to the rules of accrual basis which is more complicated than that of cash basis  .company may have to pay more taxes when switching to accrual basis as revenue is recognised at the time it is earned .accrual basis of accounting ignores the cash flow so even if the financial statements shows profit during a period , the business may still suffer from liquidity problems .

as an accountant at the Salon , I would recommend accrual basis of accounting , as this complies with the general accounting principles and have more advantages than cash basis of accounting .