accrual basis accounting

Examples of accrual basis accounting in the following topics:

• Reporting of Financial Statement Analysis

  • In the US, companies must conform to GAAP, or generally accepted accounting principles.
  • These principles are set forward by the FASB, or the Financial Accounting Standards Board.
  • Accounting Entity: assumes that the business is separate from its owners or other businesses.
  • This way of accounting is called accrual basis accounting.
  • Consistency principle: the company uses the same accounting principles and methods from period to period.

• Defining the Income Statement

  • In addition to the Single and Multi-step methods, the income statement can be reported on a cash or accrual basis.
  • An income statement reported on a cash basis is typically used by smaller businesses that record transactions based on the exchange of cash; the revenues and expenses reported reflects cash received on sales and cash paid for expenses for the accounting period.
  • Larger entities use the accrual basis, which is also the recommended method by the FASB.
  • An income statement under accrual accounting reflects revenues "earned", where an exchange in value among the parties has taken place, regardless of whether cash was received.
  • Some numbers vary based on the accounting methods used (e.g. using FIFO or LIFO accounting to measure inventory level).

• Interpreting Overall Cash Flow

  • In financial accounting, a cash flow statement (also known as statement of cash flows or funds flow statement) is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents.
  • If the accrual basis of accounting is being utilized, accounts must be examined for their cash components.
  • Analysts must focus on changes in account balances on the balance sheet.
  • The free cash flow can be calculated in a number of different ways depending on audience and what accounting information is available.
  • The free cash flow takes into account the consumption of capital goods and the increases required in working capital.

• Comparing Statement of Cash Flows with the Income Statement

  • Most importantly, revenues and expenses are reported on an accrual basis and may not accurately reflect the actual amount of cash flowing in and out of the business, respectively.
  • The statement of cash flows shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.
  • The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.
  • improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods, and

• Defining Accounts Receivable

  • The accounts receivable departments use the sales ledger, which normally records:
  • Companies have two methods available to them for measuring the net value of accounts receivable, which is generally computed by subtracting the balance of an allowance account from the accounts receivable account.
  • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.
  • Under accrual accounting, a firm can recognize revenue when it has:
  • This chart lays out methods for accruing revenue and expenses in accounting.

• The Forecast Budget

  • For example, accounts receivable, short-term financing options, and various other sources of income may directly convert into usable capital.
  • A third option for projecting cash budgets is accrual reversal.
  • This process relies on statistical distributions, reversing large accruals, and projecting cash effects via algorithms.

• Approaches to Assessing Risk

  • The assessment of risk is an integral part of risk management in general, and includes probability studies, impact of events, and takes into account the affect of every known risk on the project, and the actions needed to resolve these issues, should they occur.
  • From the average cost per employee over time, or cost accrual ratio, a project manager can estimate: the cost associated with the risk, if it arises, estimated by multiplying employee costs per unit time by the estimated time lost (cost impact, C where C = cost accrual ratio * S), the probable increase in time associated with a risk (schedule variance due to risk, Rs where Rs = Probability * S).
  • The probable increase in cost associated with a risk (cost variance due to risk, Rc where Rc = P*C = P*Cost Accrual Ratio*S = P*S*CAR): sorting on this value puts the highest risks to the budget first, which can raise concerns about schedule variance.

• Effects of GAAP on the Income Statement

  • These differences are due to the recording requirements of GAAP for financial accounting (usually following the matching principle and allowing for accruals of revenue and expenses) and the requirements of the IRS's tax regulations for tax accounting (which are more oriented to cash).
  • Such timing differences between financial accounting and tax accounting create temporary differences.
  • The historical cost principle: It requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities.

• Cash Flow Factors

  • as an alternative measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities.
  • can be used to evaluate the "quality" of income generated by accrual accounting.

• Depreciation

  • It is a concept used in accounting and economics, defined as a rational and unbiased estimate of the potential market price of a good, service, or asset, taking into account the amount at which the asset could be bought or sold in a current transaction between willing parties.
  • Where the assets produce benefit in future periods, the matching principle of accrual accounting dictates that those costs must be deferred rather than treated as a current expense.
  • Methods may be specified in the accounting or tax rules of a country.