Question

Summarize, using moral reasoning, cash or accrual basis accounting systems in relation to the selected business entity. Consider how the accounting system impacts revenue recognition, consistent with Internal Revenue Code and Treasury regulations.

Required

1- Differentiate between accrual accounting and cash basis.

2-Based on the type of business and the client’s accounting system, what is the impact when revenue is recognized?

Answer 1

1)a) Cash Basis of accounting- Using this method of accounting transactions are accounted for based on the company's cash inflows and outflows. Revenue is recorded by the company when the cash is received from customers and expenses are recorded when payment are made to vendors.Due to this, the company' s balance sheet will not include accounts receivable or accounts payable. Income which are due to be received in the current year but not received will not be recorded in income statement.

b) Accrual Basis of accounting- Under the accrual basis of accounting, transaction are accounted for when the transaction occurs or is earned, regardless of when cash is paid or received.Income is recorded when the sale occurs and expenses are recorded when the goods or services are received.

2) Whether you own a small company or a large corporation it is important to maximize the value of your accounting records so you can make the most informed and appropriate decisions for your business.The accounting method your company uses can have an impact on your ability to make these financial decisions, so it is important to choose the best method for your business.

The impact of when does a entity recognise revenue depends upon the type of company like many small and start-up companies will use the cash basis accounting method because it is typically the simpler of the two methods from an accounting standpoint. At this point in a business, companies also tend to place a lower level of importance on the financial information of the company, so the cash method is sufficient for their purposes.

From a tax perspective, the accrual method MUST be used for the following companies:

• Your company is a C corporation.
• Your company has inventory.
• Your gross sales revenue is greater than $5 million (there are some exceptions to this rule that you should discuss with your tax accountant).

If your company is required to report taxes on an accrual basis for any of the reasons above, then you should always account for your internal records on an accrual basis as well.

If your company does not meet the above criteria, then you have the option to report taxes on a cash or an accrual basis. Many times it is more advantageous to report taxes on a cash basis however, it may still be beneficial from a management perspective to use the accrual method for internal reporting purposes.