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MGT101 Financial Accounting GDB No. 01 Solution and Discussion opened on November 27,2013 Close on November 29, 2013.

Graded Discussion Board

FINANCIAL ACCOUNTING (MGT101)

 

Dear Students!

This is to inform that Graded Discussion Board (GDB) No. 01 will be opened on November 27, 2013 for discussion and last date for posting your discussion will be November 29, 2013.


Topic/Area for Discussion

 “Cash accounting Vs. Accrual accounting system”

 

This Graded Discussion Board will cover first 12 lessons.

Note:

For acquiring the relevant knowledge, do not rely only on handouts but also watch the course video lectures and read additional material available online or in any other mode.

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The cash method of accounting is typically easy to use. When a company receives money from a customer or when they pay one of their suppliers, these transactions are recorded and recognized for tax purposes.


Though the concept is simple, when using cash accounting there are a few important things to remember. First of all, even when a company is paid through some type of barter arrangement, these transactions must be recorded at the fair market cash value of what you gave or received.

Also, when using cash accounting, a company may not delay recognition of income. Income must be recognized when it is constructively received. Income come is constructively received when money is made available to the seller (whether by being posted to their account or received by their agent). This means that if a check is received on the 30th of the month, but not cashed or deposited at the bank until the 1st of the following month, it still must be recognized as income in the first month.

the accrual method, income is counted when the sale occurs, and expenses are counted when you receive goods or services. You don't have to wait until you see the money or until you actually pay money out of your checking account. With some transactions, it's not so easy to know when the sale or purchase has occurred. The key date here is the job completion date. Not until you finish a service or deliver all the goods a contract calls for can do you put the income down in your books. If a job is mostly completed but will take another 30 days to add the finishing touches, technically it doesn't go on your books until the 30 days pass.

Cash accounting is recognising the income and expenses in your business when they are physically paid rather than on receipt or issue of an invoice. Many business owners when starting out often use a simple, basic cash system, because it helps to keep track of cash flow.

“ It makes sense to recognise the debt when the bill arrives to help you keep track of money that you have and don’t have, no matter the account figures. ”

An accrual accounting system recognises both income and expenses on receipt of an invoice or bill although not yet due for payment. This system will create debtors and creditors in your accounting software, showing what you owe and when, as well as funds owed to the business from your customers. In today’s tough business environment it is more important than ever to monitor to your debotors closer and have a good system in place to reduce the number of days awaiting payment or, worse still, avoid it becoming a bad debtthat has to be written off.

CASH ACCOUNTING: 

The cash system records accounting events when they become tangible: e.g., when a customer's check arrives, when a shipped product reaches the customer, or when money for a business-related expense is removed from the bank. Cash accounting registers income when money arrives and registers expenses when money goes out the door. The cash accounting method is more familiar to most people because it's what most individuals use in tracking their personal finances. Under this method, one's income is taxable when it's received, and expenses are deductible when they're paid. Cash accounting is a straightforward and easily understood method of record-keeping for tax purposes.

Accrual Accounting: The accrual accounting method approaches accounting events in real time. When a customer signs a purchase order, the accrual system registers it as a sale - even though it may be weeks or months before you receive the full payment. Similarly, when you enter into an arrangement in which you will be paying for goods or services, the accrual system doesn't wait until you've actually paid out the money to record it as an expense. This option should help present a more accurate picture of a business' condition, yet the complexity of this method (which usually requires the aid of a finance professional to implement) also can result in an enterprise owing taxes on income it has yet to receive, which can be a serious hassle for new or small businesses that aren't flush with cash.

Cash accounting

In short, this is a straightforward system where transactions are documented as they occur. One records revenue as it comes in and expenses as they are paid. This type of accounting requires little subjective judgment as the timing (and the obviousness) of the transaction dictates when the journal entry is made. The drawback with this type of accounting is that it does not represent events which are not a business transaction or exchange, such assets or liabilities building up or expiring over time (examples being interest earned at the bank or the depreciation of computer hardware). This method is primarily useful for uncomplicated accounting situations, such as keeping the financial records of an individual.

Accrual accounting

Using this system, one records (or“recognizes”) revenue as it is earned as opposed to when it is received. Thus revenues appear as journal entries once the product or service is delivered to the customer (i.e., when assets are created or liabilities decreased), regardless of when the related payment comes in. Similarly, expences are recognized as they arise (i.e., when liabilities are increased or assets decreased) and not when they are paid out.

Accrual accounting involves two fundamental principles—to recognize the business transaction, and to periodically adjust the financial statement so that the net income  for a given period will reflect a match between that period’s associated revenues and its expenses. In applying these principles, the periodic adjustments allow for the inclusion into the accounts of economic events that did not involve a business exchange or transaction, such as interest gained at the bank or depreciation of computer equipment.

 For accounting purposes, the best method regardless of the type of business (except possibly a doctor) is the accrual-based method. Cash-based accounting can distort the true operations of your business and incorrectly reflect income.

Cash-based accounting recognizes income when money is received. Accrual-based accounting recognizes income when goods are shipped or services are rendered. Under the cash method, an expense is recognized when it's paid. Under the accrual method, an expense is recognized when the business is obligated to pay it.

So, for example, if in a given period you collect little or no receivables and you pay lots of bills, under the cash-accounting method you have expense without income; you've lost money. On the other hand, if you collect a lot of money and don't pay your bills, you have big income. That's a major distortion of what actually occurred. Accrual-based accounting doesn't care whether you've collected or paid your bills.

Income (received or not) is matched to an expense (paid or not), resulting in a proper match of revenue with the expense generated to produce the revenue. This provides a truer picture of operations.

It's possible to use one method for tax purposes and the other for accounting purposes. But as usual with tax issues, nothing is that simple. Consult with a professional tax advisor for the best tax method for you. But for accounting purposes, always use the accrual-based method.

Difference between cash and accrual accounting
Cash accounting is recognising the income and expenses in your business when they are physically paid rather than on receipt or issue of an invoice. Many business owners when starting out often use a simple, basic cash system, because it helps to keep track of cash flow.


An accrual accounting system recognises both income and expenses on receipt of an invoice or bill although not yet due for payment. This system will create debtors and creditors in your accounting software, showing what you owe and when, as well as funds owed to the business from your customers. In today’s tough business environment it is more important than ever to monitor your debtors closely and have a good system in place to reduce the number of days awaiting payment or, worse still, avoid it becoming a bad debt that has to be written off.

Difference between cash and accrual accounting
Cash accounting is recognising the income and expenses in your business when they are physically paid rather than on receipt or issue of an invoice. Many business owners when starting out often use a simple, basic cash system, because it helps to keep track of cash flow.


An accrual accounting system recognises both income and expenses on receipt of an invoice or bill although not yet due for payment. This system will create debtors and creditors in your accounting software, showing what you owe and when, as well as funds owed to the business from your customers. In today’s tough business environment it is more important than ever to monitor your debtors closely and have a good system in place to reduce the number of days awaiting payment or, worse still, avoid it becoming a bad debt that has to be written off.

The cash method and the accrual method (sometimes called cash basis and accrual basis) are the two principal methods of keeping track of a business's income and expenses. In most cases, you can choose which method to use.

The cash method. The cash method is the more commonly used method of accounting in small business. Under the cash method, income is not counted until cash (or a check) is actually received, and expenses are not counted until they are actually paid.

The accrual method. Under the accrual method, transactions are counted when the order is made, the item is delivered, or the services occur, regardless of when the money for them (receivables) is actually received or paid. In other words, income is counted when the sale occurs, and expenses are counted when you receive the goods or services. You don't have to wait until you see the money, or actually pay money out of your checking account, to record a transaction.

Advantages and disadvantages of the accrual method. While the accrual method shows the ebb and flow of business income and debts more accurately, it may leave you in the dark as to what cash reserves are available, which could result in a serious cash flow problem. For instance, your income ledger may show thousands of dollars in sales, while in reality your bank account is empty because your customers haven't paid you yet.

Advantages and disadvantages of the cash method. And though the cash method provides a more accurate picture of how much actual cash your business has, it may offer a misleading picture of longer-term profitability. Under the cash method, for instance, your books may show one month to be spectacularly profitable, when actually sales have been slow and, by coincidence, a lot of credit customers paid their bills in that month.

To have a firm and true understanding of your business's finances, you need more than just a collection of monthly totals; you need to understand what your numbers mean and how to use them to answer specific financial questions.

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