Introduction
Cash and accrual methods of accounting have been used by many organizations when preparing their financial statements. However, the accrual method is commonly used particularly by public-traded companies because it accounts for all revenues and expenses. Cash method occurs when incomes and expenditure are reported, when actual money or cash is received, or paid out respectively whereas accrual occurs when revenues are recognized when they are earned and not when funds are received. On the other hand, expenses are reported in the income statement when incurred and not when the actual cash or cash was paid out.
Income Statements
Cash-based Income Statement
| REVENUES |
$ |
| Sale of Old Merchandise |
15,000 |
| Cash deposit on orders of new merchandise |
2,750 |
| Total |
17,750 |
| COST OF SALES | |
| Cost of Old Merchandise |
10,000 |
| Purchase of new merchandise |
4,000 |
| Wages |
2,000 |
| Total |
16,000 |
| Net profit |
1,750 |
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Accrual-Based Income Statement
| REVENUE |
$ |
| Sale of Old Merchandise | 20,000 |
| COST OF SALES | |
| Cost of old merchandise | 10,000 |
| Purchase of new merchandise | 8,000 |
| Wages | 2,000 |
| Advertising expense | 1,000 |
| Total | 21,000 |
| Net Loss | (1,000) |
Reasons why Transactions were included or not included in Cash-Based and Accrual-Based Income Statements
Cash-based Income Statement
The cash-based method recognizes incomes and expenses when money is received or paid respectively. In this case, the amount of revenue recognized in the sale of merchandise to customers worth $20,000 is $15,000 ecause under cash-based accounting, incomes are presented in the income statement when customers pay cash to the company. More so, cost of merchandise worth $10,000 is included in the statement because it is the amount of cash that was paid to acquire the merchandise for sale.
In the purchase of a new merchandise transaction, $8,000 was not included in the statement because the company only paid out $4,000 and owed the rest to the account. The wage payment of $2,000 for the month was included in the cash-based income statement because it was the money or cash that left the bank or was paid out.
The receipt of $1,000 bill for advertising to be paid in November was not recognised because cash did not exchange hands even though the company incurred the expense. The $2,750 received from the customers as deposits on orders of the new merchandise transaction was recognised in the statement because the company received cash or money from the customers.
Accrual-Based Income Statement
Under the accrual-based accounting method, revenues and expenses are recognised in the income statement when earned and incurred, respectively. This act implies that incomes are supposed to be recognized before payment is received from the customers and expenses on the other hand expenses are reported when they match related revenues even if the period of payment is different. In the sale of merchandise transaction, $20,000 was reported instead of $15,000 because it was amount that the company earned on the sale of the merchandise. More so, $10,000 was recognised as cost of sales in the statement because it matched the revenue earned for the period.
In the purchase of new merchandise inventory, $8,000 was reported in the statement instead of $4,000 because, in the accrual-basis accounting, expenses are recognized when the company incurs them but not when they are paid. Similarly, payment of $2,000 for wages for the month was included in the statement because the company incurred the expenditure and it matched the revenues for the period.
Finally, the $1,000 bill for the advertising that will be paid in November was reported in the statement because in accrual basis accounting method expenses are recognized when they match related revenues. For that reason, the $1,000 bill matched revenue for the month of October despite it will be paid in the month of November. Furthermore, $2,750 received from the customers as deposit on orders of new merchandise to be sold to the customers in November was not included in the statement because the company has not yet earned the revenue. This amount will be recognized in the month of November income statement.
In conclusion, the company should use accrual-based income statement in decision-making processes because in accrual basis accounting method, the company will be able to report all its assets earned and liabilities incurred during the period. Also using accrual basis method, the company is able to obtain a better picture of its financial position.
