Cash Basis

Most of the companies use accrual accounting. Under accrual accounting a company records the revenues in the accounting period in which they are earned and realized, and records in the accounting period they are incurred. A few companies such as small retail stores and professional such as dentist, architects and doctors use cash basis accounting. Under cash basis accounting, a company records revenues, when it collects cash from sales and records expenses when it pays for its operations. On its income statement, then, the company computes its net income as difference between its cash receipts and cash payments.  In other words, net income is the same as the net operating cash flow for the period. The company may choose not to prepare a balance sheet.  However it will frequently keep track of certain assets such as amounts owed by customers (accounts receivable), amounts paid in advance (prepaid expenses) and any property and equipment it owns. It will also frequently keep track of certain liabilities such as amounts owed to supplier (accounts payable) and amounts owed to employees (accrued expenses). Cash basis accounting, however not allowed under generally accepted accounting principles (GAAP).

Sometimes a company that is using cash basis accounting must prepare its financial statements based on accrual accounting. This might happen, for instance, if the company applies for a bank loan and the bank requires financial statements prepared using GAAP. In this case, the company must convert its cash basis income statement to an accrual income statement and must prepare a related balance sheet. This involves making adjustments to the cash receipts to convert them to sales revenues and making adjustments to the cash payments to convert them to cost of goods sold and operating expenses. It also involves combining information it has about its assets and liabilities into a formal balance sheet.

Questionnaire:

• What is cash basis account?
• What are the uses of cash basis?