Question

Differentiate between Accural V. Cash based accounting
1   Describe Accrual and Cash based accounting
2   Describe Revenues, expense and excess of revenues over expenses
3   Describe Adjustments (6)

Answer 1

1 answer : The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method is a more immediate recognition of revenue and expenses while the accrual method focuses on anticipated revenue and expenses.

The Cash Method

Revenue is reported on the income statement only when cash is received. Expenses are only recorded when cash is paid out. The cash method is mostly used by small businesses and for personal finances.

The Accrual Method

Revenue is accounted for when it is earned. Typically, revenue is recorded before any money changes hands. Unlike the cash method, the accrual method records revenue when a product or service is delivered to a customer with the expectation that money will be paid in the future. Expenses of goods and services are recorded despite no cash being paid out yet for those expenses.

Example of Accrual and Cash Methods

Let's say you own a business that sells machinery. If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check. Under the accrual method, the $5,000 is recorded as revenue immediately when the sale is made, even if you receive the money a few days or weeks later.

The same principle applies to expenses. If you receive an electric bill for $1,700, under the cash method, the amount is not added to the books until you pay the bill. However, under the accrual method, the $1,700 is recorded as an expense the day you receive the bill.

2 answer : Expense

An expense consists of the economic costs a business incurs through its operations to earn revenue. Businesses are allowed to write off tax-deductible expenses on their income tax returns to lower their taxable income and thus their tax liability. Common business expenses include payments to suppliers, employee wages, factory leases and equipment depreciation, but the Internal Revenue Service has strict rules on which expenses business are allowed to claim as a deduction.

Revenue

Revenue is the amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the top line or gross income figure from which costs are subtracted to determine net income.

Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.

Revenue is also known as sales on the income statement.

Excess of revenue over expenses is the planned financial position that there will always be a sufficient amount of funds on hand to continue to run the not-for-profit entity for some period without additional funding; usually 3-4 months.

3 answer : Adjusting entries are accounting journal entries that convert a company's accounting records to the accrual basis of accounting. An adjusting journal entry is typically made just prior to issuing a company's financial statements.

To demonstrate the need for an accounting adjusting entry let's assume that a company borrowed money from its bank on December 1, 2018 and that the company's accounting period ends on December 31. The bank loan specifies that the first interest payment on the loan will be due on March 1, 2019. This means that the company's accounting records as of December 31 do not contain any payment to the bank for the interest the company incurred from December 1 through December 31. (Of course the loan is costing the company interest expense every day, but the actual payment for the interest will not occur until March 1.) For the company's December income statement to accurately report the company's profitability, it must include all of the company's December expenses—not just the expenses that were paid. Similarly, for the company's balance sheet on December 31 to be accurate, it must report a liability for the interest owed as of the balance sheet date. An adjusting entry is needed so that December's interest expense is included on December's income statement and the interest due as of December 31 is included on the December 31 balance sheet. The adjusting entry will debit Interest Expense and credit Interest Payable for the amount of interest from December 1 to December 31