Accrual Accounting

The cash basis of accounting records revenues when cash is received and expenses when cash is paid out. The accrual basis of accounting records revenues when they are earned and expenses when resources are used.

1. Describe the impact the three proposed accounting methods (full revenue recognition, deferral of revenue, and partial revenue recognition) would have on the company’s financial statements: 1) at the time of the sale, and 2) in future periods.

i) Starbucks’ financial statements follow the accrual accounting model rather than cash-basis accounting. Companies who utilize cash-basis accounting methods only recognize revenue when received in cash and expenses are only recognized when paid in cash. Accrual accounting is the recognition of revenue when earned and the matching of expenses when incurred. Starbucks records revenue from 4 different sources: Company-operated stores, licensed stores, CPG foodservice and other revenues, and stored value cards.

There are two based types of accounting measurement to determine the profit. They are cash basis and accrual basis. Business can use either a cash basis or accrual basis to work there profit. However, most of the company prefers to use accrual basis instead of others. In this essay, I will compare the difference between cash basis and accrual basis on expense and revenue. In addition, how can company choose their measurement of profit will also be discussed.

Accrual accounting attempts to measure revenues and expenses that occurred during accounting periods so they equal net operating cash flow.

Since Peyton Approved is still a new business, the accrual basis of accounting was the best system to follow because it is common and allows the company to stay on top of each transaction and how it affects the business, which is outlined in the GAAP ruled by the FASB. “GAAP rests on a conceptual framework that identifies the objectives, characteristics, elements, and implementation of financial statements and creates the acceptable accounting practices” (Nobles et al., 2014). The accrual basis of accounting lets Peyton Approved have the appropriate information and faithful representation for their financial reporting that allows them to make smart investments and decisions. Peyton Approved benefits from this basis of accounting because it provides a more precise picture of where they stand financially, through revenues and expenses recorded in that period (Nobles et al., 2014). The company is not using the cash basis of accounting because it does not follow the acceptable accounting practices like the accrual basis of accounting does. The accrual basis of accounting supports responsible practices within the company because Peyton Approved can record all prepaid and accrual expenses that will help them see how the money has been used and what decisions need to be made.

The revenue recognition principle according to Weygandt, Kimmel and Kieso (2009), "dictates that companies recognize revenue in the accounting period in which it is earned." The reporting of revenue generally affects not only the results of the operations of a given entity but also its financial position. In that regard, the relevance of understanding both the concepts as well as practices of revenue recognition cannot be overstated. In the words of Nikolai, Bazley and Jones (2009), "revenues should be recognized when (1) realization has taken place, and (2) they have been earned."

Cash accounting is the much simpler method and the method that most small start-up businesses will use because it is based on the actual flow of your cash in and out of the business. Cash basis accounting does a good job of tracking cash flow, but it does a poor job of matching revenues earned with money laid out for expenses. This deficiency is a problem, particularly when, as it often happens, a company buys the inventory in one month and sells that inventory in the next month.

Additionally many firms prefer to use cash basis in an effort to minimize the taxable income of the firm because if the firm uses cash accounting the revenue taken into account are only those that they have received cash for, whereas they could have more revenue taxed if they used accrual basis since it would even take into account the revenue for which the firm is still waiting it receive money, for example the sales paid with credit card. This may be an advantage to cash accounting but it is also an accrual accounting disadvantage since if a firm uses it, it will have to pay taxes for money that the firm has yet to receive.

According to "Cash vs. Accrual Accounting” (2000), “As you can readily see, the results produced by the cash and accrual accounting methods will only be different if you do some transactions on credit. If all your transactions are paid in cash as soon as completed, including your sales and your purchases, then your ledgers will look the same, regardless of what method you use” (para. 4).

I believe that each of these could be good for your business just depending on the business. Like to use the cash-basis you would need a business that does not have a lot of receivables and payables. If you have more receivables and payables I would suggest that you pay a little more money for the accrual basis you’re more likely to have a bigger business anyways.

Although accrual accounting is most commonly used, it is often argued which of accrual accounting or cash flow accounting is most appropriately used in a firm’s financial statements. The difference between the two methods is when expenses and revenues are realised on the financial statements, thus measuring a firm’s performance differently. This text will argue the advantages and drawbacks of respective accounting method, and further discuss which accounting method provides potential investors with the most relevant and timely financial information.

The accrual concept in accounting represents the expenses and incomes that are made in the period they take place, involving cash payments at the same time. The advantage side of the accrual approach is that financial statements include all the expenditures of the reported revenues for an accounting period.

Ultimately, companies are in the business to make money. To do this, they trade goods or services for cash, credit, or other goods and/or services of comparable value (bartering). Although some businesses rely more heavily on cash transactions, businesses would be unable to remain a going concern without long run cash inflows exceeding outflows (Megan et al., 2009). Essentially, the statement of cash flows bridges the gap between accruals and cash flows and allows for the quality of earnings to be evaluated (Ohlson & Aier, 2009). It accomplishes this task by making adjustments to the net income figure from the income statement to add back non-cash related transactions (Gibson, 2011; Megan et al., 2009). As noted by Ohlson and Aier (2009), “cash in a literal sense must have been exchanged for it to have an effect on the statement of cash flows” (p. 1093). Therefore, expenses such as depreciation and amortization that do not involve the use of cash are added

Revenues result from the sale of goods and services and include gains from the sale and exchange of assets other than inventories, interest and dividends earned on Investments and other increases in owners’ equity during a period other than capital contribution and adjustments.