In the business world there exist 2 basic accounting method Cash or Accrual. The blog is intended to guide how organizations who work on dual accounting standard can be benefitted.
- Cash Basis Accounting: Organization record only payments/receivable and not record liability against invoices. The payments/receivable distributions typically debit your expense or asset account and credit your cash or cash clearing account. But when you post payments, it creates a distribution for discount and foreign currency exchange considering gain or loss.
- Accrual Basis Accounting: Organization creates rules based on accounting distributions for invoices and payments. The invoice distributions generally debit your expense account and credit your liability account. Specifically, under the prepayments, Payables creates distributions that debit your prepayment account and credit your liability account. Rest works similar to cash basis accounting.
- Combined Basis Accounting: Organization can setup separate books for the accounting standards. However, the primary set of the book needs to be identified. Invoice distributions rules are created for accrual accounting, and while payment distributions are recorded in both. Combined basis accounting allows you to produce financial reports for either your cash or accrual set of books. For example, you may want to manage your company on an accrual basis, but require cash basis accounting information for certain regulatory reporting on a periodic basis.
Accrual accounting is useful for an organization that has to report inventory or have large accounting transaction. Considering the financial impact of loans, credit accounts and prepaid services are considered more carefully. While, Cash basis accounting, records revenues and expenses when money is actually received/paid vis-à-vis Cash basis accounting is considered to be less accurate.
It is important for the organization to know that the Internal Revenue Service (IRS) prohibits larger businesses or businesses with inventory from using cash basis accounting.
Hybrid Accounting Model helps Organization significantly
In cash accounting, income is only recorded when you receive cash. Similarly, expense occurs as soon as you issue the check to the vendor. Organization prefers cash method since it’s simpler and consume less time. One needs to be careful as the method can imbalance, credit to debt ration. It can also result in inappropriate inventory balance.
In accrual, income is booked when sales are recorded, despite being tangible or intangible sales and regardless when you get paid. A similar rule applies at the time of expense. An accrual accounting method is most commonly used as it gives you accurate financial health of the organization.
Importantly, there is also a difference in both accounting methods for both revenue and expense. There are four scenarios where revenue and expense recognition may not coincide with cash transactions. The following are four types of scenarios with relevant timing differences are:
- Revenue is recognized ‘before’ cash is received Accrued Revenue
- Expense is recognized ‘before’ cash is paid Accrued Expense
- Revenue is recognized ‘after’ cash is received Deferred Revenue
- Expense is recognized ‘after’ cash is paid Deferred Expense
Accrual method records more transaction in comparison to cash accounting. Organization nowadays uses on account method to bring cash into books of account and later enters the receipt as another transaction. This helps them to knock off entries against expense entries.
With Oracle Application, this is probably not a big concern, since the application automates much of the extra effort required by the accrual method. With the cash method, the only transaction that is recorded is when the customer pays the bill.
Important for an organization to know that Generally Accepted Accounting Principles (GAAP) requires companies to use the accrual basis for financial reporting purposes; it is considered a more accurate depiction of a company’s income and expenses. Oracle Application can help these organization to record the transaction, maintain dual accounting standard and automate processes for easy reconciliations. For more information please visit www.prudencesoftech.com