Cash vs. Accruals: Is There a Difference in Recognizing Transactions - Essay Example

Such incorporation of monetary value can be done on either cash or accrual basis. This paper seeks to investigate the differences between cash and accrual recognition of transactions. The paper will explore elements and principles that are involved in the two approaches to recognition. Cash method The cash approach to accounting recognizes transactions when money is transferred between parties. A transaction is therefore not considered to have occurred unless money has been transferred from one party to another.

This means that credit sales by an enterprise will not be recorded as a transaction until that time when the debtors remits their payments. Similarly, credit purchases are not considered until the time when the organization pays for its debts. The same treatment applies to accruals and prepayments that are not recognized as bases for transactions because money is not transferred in the processes. Other accounting treatments that do not involve real flow of money into the enterprise or out of the enterprise are also not recognized under the cash recognition approach.

The cash approach to accounting therefore does not recognize depreciation on assets as an item of financial transaction (Allen, 2011). One of the characteristic features of cash approach to accounting is lack of timely realization of items of transactions. Recognizing transaction when money is received or paid means that the transactions may not be acknowledged in the accounting period in which they occurred. A consideration of prepaid expense for instance realizes the whole transaction as a payment for one period.

A prepayment for an insurance policy that covers a five year period of time may be recorded as an expense for the current year or even month. As a result, no values for expenses will be acknowledged in the other years for which the prepayments are supposed to cover (Allen, 2011). Though the cash accounting approach is simple to operate, it has a number of disadvantages. One of the immediate disadvantages of the method is that it does not match revenues earned in a given period with the corresponding expenses that are incurred in realizing the revenues.

Revenues that are received in cash in a period of time might not be matched with their respective expenses if such expenses were not paid for. This complicates the financial position in the sense that the revenue expenses for a given period will not be the actual value for realizing the revenues. As a result, real profit made or loss incurred in a given accounting period may not be ascertained. An institution’s balance sheet under the cash accounting approach may not represent the actual financial position of the enterprise due to non recognition of items such as accounts payables and accounts receivables (Allen, 2011).

Accrual accounting approach Under the accruals approach to accounting, transactions are recognized when they take place and not when consideration is transferred. Money does not need to be involved for recognition to be done. The accrual concept of accounting, according to Advani, is based on the principle that “businesses are assessed not so much on what they have on hand, but rather on their expectations and potential” (Advani, 2006, p. 6). The concept, based on this principle, recognizes items that an enterprise is supposed realized in any period but are incurred or gained in the current period (Advani,