22/07/2023
Lesson 23
➡️ Accrual-Basis Accounting :-
If we could wait to prepare financial statements until a company ended its operations, no adjustments would be needed. At that point, we could easily determine its final balance sheet and the amount of life time income it earned.
However, most companies need feedback about how well they are performing during a
period of time. For example, management usually wants monthly financial statements.
The Internal Revenue Service requires all businesses to file annual tax returns. Therefore, accountants divide the economic life of a business into artifi cial time periods. This convenient assumption is referred to as the time period assumption.
➡️➡️ Fiscal and Calendar Years :-
Both small and large companies prepare financial statements periodically in order to assess their fi nancial condition and results of operations.
Accounting time periods are generally amonth, a quarter, or a year.
Monthly and quarterly time periods are called interim periods.
Most large companies must prepare both quarterly and annual financial statements.
An accounting time period that is one year in length is a fiscal year.
A fiscal year usually begins with the first day of a month and ends 12 months later on the last day of a month.
Many businesses use the calendar year (January 1 to December 31) as their accounting period. Some do not.
➡️ Accrual- versus Cash-Basis Accounting :-
Under the accrual basis, companies record transactions that change a company’s financial statements in the periods in
which the events occur.
For example, using the accrual basis to determine net income means companies recognize revenues when they perform services (rather than when they receive
cash).
It also means recognizing expenses when incurred (rather than when paid).
An alternative to the accrual basis is the cash basis.
Under cash-basis accounting, companies record revenue at the time they receive cash. They record an expense at the time they
pay out cash.
The cash basis seems appealing due to its simplicity, but it often produces misleading financial statements. For example, it fails to record revenue for a company that
has performed services but has not yet received payment. As a result, the cash basis may not recognize revenue in the period that a performance obligation is satisfied.
Accrual-basis accounting is therefore in accordance with generally accepted accounting principles (GAAP).
Individuals and some small companies, however, do use cash-basis accounting.
The cash basis is justified for small businesses because they often have
few receivables and payables. Medium and large companies use accrual-basis accounting.
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20/07/2023