Finance Management Discussion Questions Explain the Difference Essay

Finance Management (Discussion Questions)

Explain the difference between the accrual basis of accounting and the cash basis of accounting. What are the major reasons for accrual accounting? How are revenues defined under accrual accounting?

First Student

In the words of Snyder (2008), "the difference between cash and accrual basis accounting has to do with the time frame in which revenues and expenses are recorded and reported." According to the author, revenues when it comes to the cash basis of accounting are recorded on receipt. This could be before or even after the said revenues are earned. On the other hand, revenues as per the accrual accounting approach are recorded once they are earned (Snyder, 2008). This could be before or after the said revenues are received. Next, when it comes to the cash basis of accounting, expenses according to Snyder (2008) are recorded on payment. This could be before or even after they are incurred. On the other hand however, under accrual accounting, expenses according to the author are recorded on being incurred -- which could either be before or after they are paid.

It is important to note that there are a number of reasons for accrual accounting. To begin with, accrual accounting ensures that a specified financial period's charges and income are recorded (in actual terms) as being part of that particular financial period. Accrual accounting also allows for the appropriate disclosure of liabilities and assets. By following the matching principle, accrual accounting also essentially contributes towards the presentation of a true picture of a business entity's sustainability and profitability for any given period.

Revenues on this front according to Norton, Diamond, and Pagach (2006) are basically "defined as inflows or other enhancements of the assets of an entity or settlement of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities…" (p. 254). Expenses on the other hand as the authors point out are "outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities…" (p. 254).

Second Student

While cash method according to Investopedia (2013) accounts for revenue on the receipt of money, revenue when it comes to accrual accounting is accounted for when it is earned. Expenses on the other hand in the case of cash accounting, as Investopedia (2013) observes, are accounted for when money is paid out. With regard to accrual accounting, goods and services are expensed when they are incurred (Investopedia, 2013).

When it comes to the reasons for accrual accounting, it is important to note that this particular basis of accounting offers the most accurate/correct view of the current condition of a company. Revenue streams when it comes to credit sales are likely to be provided over a long period of time. Given that this has an impact on the financial condition of a business entity at the point of sale, it is only appropriate that such events be mirrored on the same reporting period's financial statements. It should however be noted that accrual accounting, in comparison to cash basis of accounting, is regarded more complex.

An expense according to Investopedia (2013) represents all those economic costs incurred by a business as it seeks to earn…