Question

Some would suggest that the Statement of Cash Flows can be more easily represented in a cash-basis Income Statement. What is your opinion of this - and would it be better to have financial activity recorded as a cash-basis rather than accrual?

Answer 1

cash flow statement shows exactly how much money a company has received and how much it has spent, traditionally over a period of one month. It captures the current operating results and changes on the balance sheet, such as increases or decreases in accounts receivable or accounts payable, and does not include non-cash accounting such as depreciation and amortization. A cash flow statement is used to determine the short-term viability and liquidity of a company, specifically how well it is positioned to pay its bills and vendors. An income statement is the most common financial statement and shows a company's revenue; total expenses, including non-cash accounting such as depreciation; and profit or loss, traditionally over a period of one month. An income statement is used to determine the financial performance of a company, specifically how much revenue it made, how many expenses it paid, and the resulting profit or loss from the revenue and expenses.

The cash flow statement is linked to the income statement by net profit or net loss. The profit or loss on the income statement then is used to calculate cash flow from operations. This is referred to as the indirect method. The direct method can also be used to prepare the cash flow statement, where the money received is subtracted from the money spent to calculate the net cash flow.

The statement of cash flows was created due to a lack of cash flow information on the income statement, balance sheet, and statement of owners’ equity. The income statement shows revenues and expenses using the accrual basis of accounting, but it does not indicate how much cash was received for revenues or paid for expenses.

Few transactions of cash flow can be represented in cash-basis income statement but whole statement of cash flows can't be easily represented in cash-basis income statement. Like, Purchase of property plant and equipment, cash flow from issue of shares, Repayment of borrowings, cash flow from sale of fixed assets can't be shown under cash-basis income statement.

The cash method of accounting is the simplest method and the method that is most familiar to the majority of people. It also gives you the best picture of how much cash you truly have available for operating your business. However, it can offer a biased picture of your profit and loss as expenses and revenue are often recognized in different period.

The accrual method of accounting does a better job of matching income and expenses to the appropriate period. This gives you a better picture of your true profit or loss. However, the accrual method tends to obscure your view of how much operating cash you actually have available, so you might need to prepare frequent cash flow statements to get a better picture. The accrual method is also more complicated and time-consuming to execute, often requiring the support of accounting professionals to execute and analyze.

Under the cash basis of accounting:

- Revenues are reported on the income statement in the period in which the cash is received from customers.

- Expenses are reported on the income statement when the cash is paid out.

Under the accrual basis of accounting:

- Revenues are reported on the income statement when they are earned—which often occurs before the cash is received from the customers.

- Expenses are reported on the income statement in the period when they occur or expire—which is often in a period different from when the payment is made.

The accrual basis of accounting provides a better picture of a company's profits during an accounting period. The reason is that the income statement prepared under the accrual basis will report all of the revenues actually earned during the period and all of the expenses incurred in order to earn the revenues.

The accrual basis of accounting also provides a better picture of a company's financial position at a moment or point in time, because all assets that were earned are reported and all liabilities that were incurred will be reported.

The accrual basis of accounting is required because of the matching principle.