Accrual Accounting | Advantages & Disadvantages | Examples

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be some examples of you discussing and what are the advantages and
disadvantages of the same so let’s get into the nitty-gritty of the same the
first in the foremost thing what you can see over here is the accrual basis of
accounting cash in cash receivables equivalents receivables net of allowance
73 and 15 and respectfully so and this this data is of Colgate SEC filing so
now what exactly over here accrual basis or a accrual accounting basis is all
about see accrual accounting basis is one of the most accepted methods in
accounting in a accrual accounting the revenue is recognized when the sale is
done so irrespective of the cash or the credit sale and the expense is
recognized when it is incurred and irrespective of whenever it has been
paid so accrual accounting is used by the most business owners as for the
accrual accounting the accountant records an expense or revenue when it
occurs it has nothing to do with cash inflow or the time of the cash inflow
and so on and so forth so accrual accounting is the basis of one
accounting principle that is matching principle as for the matching principle
one needs to to record the expenses in correspondence with the revenue so
expense in correspondence with the revenue now for example as a business
owner if you record the sales you also need to record the cost of the goods
sold at the same time it’s like sales and you have to record COGS as a
present but why most businessman use accrual basis of accounting or accrual
accounting basis the main reason for using accrual accounting is to
get a fare and an accurate picture of the business at any given stage let’s
say that you as an investor want to know where a business stands at any given
point of time so what would you want to know you would want to know how a
business is doing right now and now what business will receive in near future so
if a company is using the accrual accounting accrual basis of accounting
then as an investor you won’t be in doubt whether the current affairs of the
company is in the most accurate or not so accrual basis of accounting showcase
exactly what is happening in the business not what a business will
achieve in the near future like for example if a firm has sold products on
credit basis accrual basis of accounting will show the same as sales even even if
the money is yet to be received by the company another important point that I
want to highlight over here about accrual basis of accounting is that
accrual accounting is applicable for the business which are relatively medium to
large and which earns a decent amount of the cash flows during a year
now let’s understand a measuring grid for accrual basis of accounting see
there is not always an exact figure to find out whether you should use cash
accounting or accrual accounting but still there is a structure that is being
followed by the market so you can you can call it a rule or a guideline here
it is if your business is selling let’s say more than $5 billion dollar
million dollar I’m sorry in in a year and if you are a corporation then you
should go for accrual basis of accounting otherwise you should go for cash
accounting and you may ask why this is the question it is a general rule the
reason behind this is the number of transaction and in case of sole
proprietorship and the lesser revenue the number of transactions are fewer and
that’s why in this case cash accounting is great but for the corporations and
the large revenue the number of transactions are so many that the
accrual basis of accounting is best now let’s discuss the example let’s look at
few practical examples of accrual basis of accounting see accrual basis of
accounting will we’ll be discussing this as the example number one accounts
payable so I’ll write EC payable over here
difference Limited is one company let’s say has a salary that is payable close
enough to let’s say 40,000 how would we treat it as for the accrual basis of
accounting as for the accrual basis of accounting the effect of the transaction
would be to dimension that means one needs to record this transaction in two
places first it would be recorded as a salary expense okay and in in the
basically in the P&L that is the income statement and then it would be treated
as a current liability so in that scenario and it will be also be recorded
in the balance sheet right so let us now look at the practical example of the
accrual basis of accounting I’ll show you a snapshot of Colgate’s current
liability and we’ll we’ll take out some conclusion of that
as you can see over here the accounts payable over here one one two four and
that is because for these sources as for the coal gets SEC filing the next
example that we are going to discuss is example number two that will be for
prepaid expenses will begin prepaid expenses now similar limited that is new
company has prepared of wages of let’s say 1 lakh dollar right and how would we
treat it as for the accrual basis of accounting see this transaction is
opposite of the previous example that was the one that we discussed accounts
payable as for the accrual basis of accounting you will treat in a similar
way we will record the transaction in two places the first that we’ll record
is as wages expenses in the P&L that is D income statement and we will also
record the prepaid wages okay under the current assets of the balance sheet
let’s now look at another practical example of the accrual basis of
accounting I will show you a snapshot of the Facebook’s balance sheet and what we
will note that Facebook has reported prepaid expenses of 959 million and 659
million in 2016 and 2015 respectively let me show you that as you can see the
prepaid expenses of Facebook prepaid expense and other current assets 959 and
659 respectively this is the sources as for the Facebook SEC filing the next
example that we are going to learn that is example number three and that will be
for accounts receivable which we call as daters so there’s a company let’s say
equal Limited has a total sales or let’s say $1,000,000 out of the total sales
let’s say 60% is in cash and how would we treat this transaction under the
accrual accounting so as for the accrual basis of accounting 40% of the sales are
great sales but the great sells will also be treated as sales and profit
would be generated by including both the cash and the great sales
and then the ducting the cost of the good Souls and the operating expenses if
it were a cash accounting we wouldn’t have recorded the great sales like I’ll
show you again an example of a cold Bischoff accounting taken from the coal
gets balance sheet and let me show you a screenshot of the same first what we
know do we hear that receivable or net of allowance is seventeen fifty two
fifty nine one one forty one is the amount or million or and one four to
seven in 2016 and 2015 respectively for receivables data now let’s discuss the
advantages and disadvantages of accrual basis of accounting there are many
benefits the first is it is a really a holistic approach sir unlike cash
accounting accrual accounting is a very holistic accounting system you would
agree that you know the business is not about cash only there are many aspects
that should be taken into account under accrual system we can record all the
financial transactions of the business cash and others and we can also create
financial statements like income statement balance sheets to get more
holistic view of how the company’s doing over on second they are almost no
discrepancy or you can say no errors since the financial transaction is
immediately recorded as it occurs there are almost no chances of discrepancies
or error and since everything is recorded it or all the time if one wants
to do an order the information is easily available
the third is there is a high level of accuracy over here we can say that
unlike cash accounting occur or accounting follows double-entry system
that means that one account is debited in another account is created as a
result we can see that how one account is reduced and another condenser has
increased and it increases the accuracy level of the accounting and later on
during the audit things get real easier the fourth point is that it is
recognized by the Companies Act another benefit of accrual accounting is
that it is recognized by the Companies Act and and that’s why a huge number of
the companies follow accrual accounting instead of the cash accounting let’s
discuss some of the disadvantages the first disadvantage are
it’s quite complex okay it’s quite complex cash accounting is cash
accounting is easy to record and easy to maintain
but accrual accounting is very difficult to record since every time of financial
transaction happens there should be an entry in the books of accounts and
maintaining the whole accounting system isn’t a that easy job as well and the
second is holistic but it is difficult to maintain that is very big thing and
sell a business has different aspects and if a business is huge in a single
day hundreds and thousands of the financial transaction needs to be
recorded under the accrual accounting maintaining all of this every day day
after day isn’t an easy job for an accountant so that’s it for this
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