Accounting and Finance Essay Example

a business is paid in advance for work to be done in the future. Using the contractor example, revenue will be recognized when the work is actually done, as payment was made in advance. Generating a more precise financial statement allows for predictions about future income and financial standing.

Using accrual accounting, the document can aid in management accounting by facilitating budget preparation and supporting decision-making. Additionally, the accrual basis enables managers to quickly determine whether their business is profitable or not by matching income with expenses, thus providing a better assessment of profits. However, there are drawbacks to accrual accounting, such as its complexity and the fact that net revenue may not equal the change in cash during the financial period.

This indicates that occasionally, a business can have revenue that has been earned but not yet recognized; the complete revenue may be in cash before it's actually handed over due to credit sales and purchases received after the current fiscal year. The balance of cash at bank cannot be representative of revenue as sales might not be recognized during the present fiscal year. Sometimes, despite revenue receipts that remain unrealized, the government may still charge income taxes on net revenue. The predicament is that the business hasn't yet been paid, yet income taxes are required to be paid on an unrealized revenue transaction.

Due to the recognition of revenues and expenses prior to receipt and payment, a business can find itself in a situation where it is making a profit while its bank account is overdrawn. This can occur when prepaid revenue is received prior to the purchase of goods, leading to payment to creditors (Trade

payables) before their arrival. Additionally, sales may be recorded and included in the income statement even if payment has not yet been received from debtors (Trade receivables). As such, timing differences may result in cash-flow issues for the organization.

To sum up, the accrual accounting method is widely employed in creating financial statements due to its objectivity and realism in recognizing revenue and expenses. This approach depicts the profitability of a business in financial statements with clarity, despite no exchange of cash having taken place. Nonetheless, it is complicated, and the net revenue is not reflected in the cash balance at the bank. Credit sales transactions can also pose a challenge as the delivery of services or goods may not occur when the invoice is received from debtors, rendering the accrual basis less dependable for liquidity and cash flow. As an alternative, the cash basis approach can be adopted in preparing financial statements.

The cash basis records transactions based on actual cash flow, reflecting changes in cash entering and leaving the business. This approach does not consider profitability, as revenue and expenses are not always directly related to cash changes. Instead, profit is derived from actual revenue and expenses. In contrast, the accrual basis is generally preferred as it provides a more long-term view of revenues and expenses. Bibliography:http://www.

Two web addresses regarding accounting methods and accrued revenue: referenceforbusiness.com/small/A-Bo/Accounting-Methods.html and moneyinstructor.com/doc/accruedrevenue.asp