Accounting practices are the laws that a business must obey when reporting sales and expenses. The two main accounting techniques are accrual accounting (which is commonly used in businesses) and cash accounting (generally used by individuals). Cash accounting records profits and losses as they are earned and compensated by cash inflows and outflows; accrual accounting records revenues and expenses as they are received and incurred through credit transactions and purchases, as well as the use of accounts receivable and payable. Commonly recognized accounting standards include the use of accrual accounting (GAAP). If you're having trouble getting started on your accounting homework, visit our College Accounting Homework Help page for some pointers. Our experts will be delighted to assist you.
Officially, cash-basis accounting and accrual accounting are the two forms of accounting approaches that govern how a company's transactions are reported in its financial books. The way the company tracks cash coming in and out of the business is the main difference between the two forms. There's a lot of space for error — or exploitation — inside that simple gap. Many of the large companies embroiled in financial scandals have gotten themselves into trouble because they messed around with the nuts and bolts of their accounting system.
Let's Discuss Briefly both types of accounting methods
Companies report costs in financial statements when the cash is actually set out, and they book earnings when they have the cash in their hot little hands or, more likely, in a bank account, according to cash-basis accounting. For example, if a painter finishes a project on December 30, 2003, but doesn't get paid until January 10, 2004, when the owner inspects it, the painter records those cash earnings on her 2004 tax return. Checks, credit-card receipts, and any other source of income from customers are considered cash earnings in cash-basis accounting.
Smaller businesses that haven't officially incorporated, as well as the majority of sole proprietors, use cash-basis accounting because it's cheaper to use on their own and eliminates the need to employ a broad accounting team.
When a corporation uses accrual accounting, income is recorded when the transaction is done (for example, when work stated in a contract agreement between the company and its client is completed), not when the money is received. That is, even though the consumer hasn't paid yet, the company reports revenue when it is earned. A carpentry contractor that uses accrual accounting, for example, reports the revenue received when the job is finished, even though the client hasn't paid the final bill yet.
Expenses are treated in a similar manner. And if it hasn't paid for the materials yet, the company reports any costs as they occur. When a carpenter buys lumber for a job, for example, he will do so on the account and not pay for the lumber until he receives the bill a month or so later.
Why does the process matter?
The accounting system a company employs may have a significant effect on the actual income it records as well as the costs it deducts from revenue to arrive at the bottom line. Here's how to do it:
Cash-basis accounting: On a month-to-month basis, expenses and sales aren't meticulously balanced. Even if the costs were incurred in previous months, they aren't remembered until the money is actually paid out, and sales obtained in previous months aren't recognized until the cash is actually collected. Cash-basis accounting, on the other hand, excels at measuring the real cash available.
Accrual accounting: Expenses and sales are balanced, giving a business a clearer picture of how much it costs to run each month and how much profit it makes. Even if the money isn't paid out in the following month, expenses are reported (or accrued) in the month they're incurred. Even if the company has not yet obtained payment from the client, revenues are reported in the month the project is completed or the product is delivered.