Week 3: Accrual and Cash Accounting Methods
Accrual and cash are the two main aspects of accounting. In accrual basis, revenue and expenses are recognized in their respective accounts when transactions occur rather than upon receipt of payment (Gnanarajah, 2014). Separate adjusting entries are prepared to allocate these transactions. An example is the accrued revenue journal entry, where unpaid income is recorded. Businesses that keep such journals often have an accurate measure of their financial performance in every fiscal year.
The accrued revenue journal entry has a debit and credit side. Expense accounts are debited in the adjusting entry when an expenditure occurs (Gnanarajah, 2014). Similarly, the expense is adjusted in the income statement to account for all overheads that arise in a given financial year. On the other hand, payable accounts are credited. Hence, this entry is included in the balance sheet as a liability.
Journal entries are subject to errors, including principle and commission. Failure to record an adjusting entry results to an error of omission. The fault may be reflected on a balance sheet and an income statement. For instance, failure to account for an expense account for the year in which the transaction occurs may result in an overstatement of the net income. The income statement may not reflect all expenses incurred during the financial year. Similarly, the omission of payable accounts may convey inaccurate report of a firm’s assets.
Lastly, each journal entry has a counterpart adjusting entry. For example, the equivalent for accrued revenue is accrued expenses, which is an entry that records unpaid expenditure. An example of an accrued expense is payable loan interest. For purposes of taxation and in determining the financial performance of a firm, financial analysts should ensure that all adjusting entries are recorded in their respective accounts.
Reference
Gnanarajah, R. (2014). Cash versus accrual basis of accounting: An introduction. Congressional Research Service, 1-20. Retrieved from https://fas.org/sgp/crs/misc/R43811.pdf
