Why are accrual-basis financial statements more useful than cash-basis statements? (Ignore the SCF for the moment) 2

1. Accrual basis financial statements help in matching revenues with expenses for a given accounting period.

Under the accrual basis, revenues are recognized when they are earned, and expenses are recognized as they are incurred.

For example, under the cash basis, cash received in advance for services to be performed in future would be recognized as revenue in the period in which the cash is received, which would give a skewed picture of the financial results to the users of the financial statements. Under the accrual basis, revenue would be recognized inthe period in which the services are actually performed.

2. The cash account reflects the cash basis of accounting. Whenever cash is received or paid, the transaction is recorded in the day books. Therefore, no subsequent adjustment is required for cash account. Therefore, adjusting entries will never include cash. Adjusting entries are done to make the books reflect the matching principle – match revenue and expense of the operating period. Every adjusting entry would involve an income statement account, and a balance sheet account ( other than cash ).

3. A company gets assets through :

• Operating activities, e.g, sale of merchandise, or collection of receivables
• Investing activities, e.g., Purchasing fixed assets, or sale of investments
• Financing activities , e.g., issuance of stocks for cash and other assets, borrowings

4. The following reasons could explain why in spite of the books being incorrect, the trial balance would balance:

• Errors of principle: a capital expenditure being treated as a revenue expenditure or vice versa. For example routine repairs and maintenance expense being debited to equipment account.
• Compensating errors : An error on the debit side of the trial balance being exactly compensated by an error on the credit side. For example, an undercasting of the sales account of $ 2,000 being compensated by an undercasting of $ 2,000 in the advertising expense account
• Errors of complete omission: When transactions have been totally omitted to be recorded. This error would affect neither the debit side nor the credit side of the trial balance.
• Errors of duplication : When the same transaction has been recorded more than once.

5. There is no alternative of double entry book keeping. The duality concept forms the foundation of the accounting system. For every give, there is a take, for every benefit there is a sacrifice, and for every debit there is a corresponding credit.

6. The income statement accounts ( revenues and expenses ) are temporary accounts. They are known as temporary accounts because they are closed at the end of each reporting period to the retained earnings account ( comprised of accumulated undistributed profits ) , which is carried in the balance sheet to the next accounting period. All balance sheet accounts ( assets, liabilities and equity ) are permanent accounts which are carried from one accounting period to the next.

The temporary accounts are necessary to reflect the operating results of the company during the reporting period, i.e, whether the business was profitable or not.

The permanent accounts reflect the financial position of the company as on a given date. Assets = Liabilities + Equity. An excess of assets over liabilities tells you that the company is liquid and solvent, and would be able to pay off its liabilities in due course. It also tells you whether the owner's equity has grown over the years or not.