Question

Reporting entires can prepare their financial statement using cash basis or accrual basis of accounting. Is this statement correct? Discuss with reference to the accounting standards and conceptual framework of accounting

Answer 1

Under Cash basis of accounting , revenues and cost are recognized on receipt of cash or payment of expense.Revenue is recognized only when cash associated with the income is received by the business .Similiarly , expenses are not recognized until cash associated with expenses is actually paid. Adopting Cash basis of accounting is much convinient and easier but using it for financial reporting purpose can be misleading as it can distort the results of financial activity.

Accrual basis of accounting requires that revenue be recorded when earned and expense should be recorded when incurres , irrespective of when related cash movement occurs.Accrual accounting provides a better view of companies operational abilities by spreading out its revenue recognition and receivables.Under the general accepted accounting principles (GAAP) , reporting entities are allowed to follow accrual basis of accounting to provide better sense of company's overall financial health.

Further , one of the baisc principles of accounting 'matching principle' that follows accrual basis states that expense should be recognized and recorded when that expenses can be matched with the revenues earned from that expenses.