Introduction:
As a business owner, it is very important to know the rules of accounting that are to be used. This helps anyone to follow the right procedures when preparing a financial statement. If the owners do not have the accounting expertise, they would have to hire an accountant. In this scenario, we need to explain to Kramer and Newman the importance of cash and accrual basis of accounting and when they should be used. Finally, I recommend the best method they should consider employing for their business.
Cash Basis of Accounting:
This is a method of accounting where the revenues are recorded on the day they are received. Additionally, all expenses are recognized when they are paid out. This means that this technique does not take into consideration any accounts payable or receivable because it only applies to the payments made and received by the business. However, it is evident that small business owners choose to employ cash basis of accounting because of its simplification in preparing financial statements. It is simple to track the transactions that have taken place within the bank because there is no significance to recording account payables and receivables. Also, another advantage for small businesses is that they are not required to pay income tax on any revenue generated until it is deposited into their bank account. However, this method has its limitations such as producing an inaccurate picture of how the enterprise is performing. The reason being it does not account for all transactions that take place. As a result, it can mislead the owners into making wrong decisions, thinking they have good cash flow when, in reality, the business is performing poorly.
Accrual Basis of Accounting:
This is a method that is mainly used by large organizations in preparing their financial statements. It can also be used by small enterprises that wish to grow or want to see a clear picture of what is happening in the organization. Therefore, we can conclude that accrual is the opposite of cash basis of accounting. It is a technique in which revenues and expenses are recognized when they are earned and billed. This means that they do not care if they have received or paid the money that is required.
Accrual basis of accounting is a good method because it gives small business owners a clear picture of the expenses and revenues that they expect within a certain period. This can help a person to measure the performance of the business on a regular basis and be in the position to make vital decisions for future growth or expansion. However, the disadvantage of using this method is that it does not take into account funds that are in the bank. As a result, it requires individuals with good bookkeeping practices to make this technique successful. This is because books of account can reflect vast amounts of revenue whereas the bank does not have anything.
Recommendation:
From the explanation given, it is evident that the business in question is a big one and probably a company. Therefore, it is crucial for them to employ the accrual basis of accounting in preparing their financial statements. This will help them to have a realistic picture of business performance over time. Additionally, it is obvious that they will be paying taxes, so this method helps them in computing the amount of taxation they are supposed to pay.
