Friday, February 10, 2012

Accrual and Cash Accounting

Fra Luca Pacioli Letter A 1509Image via Wikipedia

Accrual accounting is basic accounting that recognizes when income is earned and how expenditures are incurred. Accrual accounting is usually recorded at the end of an accounting period despite cash not being paid or received. One example of accrual accounting is dividend, accrued salary, and income earned on stock. Understanding the importance of double-entry bookkeeping which is recording transactions in two accounts and with each account having two columns was the work of Luca Pacioli who documented it in his celebrated work Summa (Rey, 2008). Accrual accounting should not be confused with actual accounting. Unlike cash accounting which is used by businesses that have no employees or inventory, accrual accounting has become a generally accepted accounting principal (GAAP) because income is measured when it is earned and expenses when incurred. Accrual accounting is not meant for commercial governmental organizations even though it is underlined that it should be used in the management of government financial resources (Jones, 2008).

The primary objective of providing the basics for accounting is to allow management to comprehend and have a firsthand knowledge of the necessary information required for decision making. Understanding the basics of accounting requires having knowledge of the concepts of computation per units, preparation of financial statements, and computation of relevant costs that are part of basic accounting costs. In accrual accounting organizations will have a better picture of their financial positions one way or the other. Accrual accounting is used in countries such as Australia, New Zealand, the Netherlands, Switzerland, and the United Kingdom. In the U.S., GAAP requires government entities to use full accrual accounting which is the method for the private sector (Mikesell, 2011). Thus, it is undesirable for organizations to use cash accounting in their business transactions. Instead, it is preferable to stick to accrual accounting which has become the norm of business transactions for modern organizations.

References

Jones, R. (2008). Implementing reforms in public sector accounting: Comparative international governance accounting research. Susan Jorge (ed.). Imprensa da Universidade de Coimbra.

Mikesell, J.L. (2011). Fiscal Administration: Analysis and applications for the public sector (8th ed.). Boston, MA: Wordsworth Cengage Learning.

Rey, J.D. (2008). Algebraic operations in an early-sixteenth century Catalan manuscript: An approach to the possible sources. Seminarid d’historia de la cienca Universitat Pompeu. Retrieved from http://www.upf.edu/hciencia/docampo4.pdf
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