learn finance - accrual and cash accounting
TRANSCRIPT
CASH & ACCRUAL ACCOUNTING
Yiannis Megaloeconomou, MBA
LEARNING OUTCOMES
• What is cash and accrual accounting?
• What is their main difference?
• Examples on cash and accrual accounting on sales revenue and expenses
• Advantages and disadvantages of cash and accrual accounting
• Practicing cash and accrual accounting
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Cash versus Accrual Accounting
Cash and accrual accounting are the two
principal methods for recording income
(sales revenue) and expenses for a business
The difference between the two accounting
methods is when (the time) revenue and
expenses are recognized
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
Cash Accounting
• Recognizes revenue at the time
payment has been received no matter
when the sale was made
• Recognizes expenses at the time
payment for goods and services has
been made regardless of whether the
expenses were incurred or not
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
Cash Accounting
Revenue Recognition example 1
When a business delivers goods to a customer in January and payment is received in February, then revenue will be recorded at the time of payment received, meaning in FebruaryCash & Accrual Accounting
January February
GoodsDelivered
PaymentReceived
$$
Record Sale $$
Yiannis Megaloeconomou, MBA
Cash Accounting
Revenue Recognition example 2
When a business delivers goods to a customer in February and payment has been received a month earlier in January, then revenue will be recorded at the time of payment received, that is in JanuaryCash & Accrual Accounting
January February
GoodsDelivered
$$
PaymentReceived
Record Sale $$
Yiannis Megaloeconomou, MBA
Cash Accounting
Expense Recognition example 1
In case an employee worked for a business during
March and payment for his/her services has been
made in April the salary expense for the employee
will be recorded in April, at the time of paymentCash & Accrual Accounting
March April
ServicesReceived
PaymentMade
$$
Record Expense $$
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Cash Accounting
Expense Recognition example 2
In case an employee worked for a business during March and payment for his/her services has been made a month earlier in February, then the salary expense for the employee will be recorded in February, at the time of payment
Cash & Accrual Accounting
February March
ServicesReceived
$$
PaymentMade
Record Expense $$
Yiannis Megaloeconomou, MBA
Accrual Accounting
Recognizes revenue at the time goods or
services are delivered no matter when
payment is received
Recognizes expenses at the time
expenses are incurred no matter when
payment is made
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
Accrual Accounting
Revenue Recognition example 1
When a business delivers goods to a customer in
January and payment is received in February, then
revenue will be recorded at the time they were
earned, that is in JanuaryCash & Accrual Accounting
January February
GoodsDelivered
PaymentReceived
$$
Record Sale $$
Yiannis Megaloeconomou, MBA
Accrual Accounting
Revenue Recognition example 2
Receiving Advance PaymentsA business receives payment from a customer in January but services will be rendered in FebruaryIn this case revenue cannot be recorded in January Instead, the business has created for itself a liability to its customerRevenue will be recorded once the business provides services to its customer in FebruaryCash & Accrual Accounting
January February
ServicesProvided
$$
PaymentReceived
Record Sale $$
Yiannis Megaloeconomou, MBA
Access 3+ hours of Videos+ Practice Problems.
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Accrual Accounting
Expense Recognition example 1
In case an employee worked for a business during March and payment for his/her services has been made a month later in April, then the salary expense for the employee will be recorded in March, at the time of employee services
Cash & Accrual Accounting
March April
ServicesReceived
PaymentMade
$$
Record Expense $$
Yiannis Megaloeconomou, MBA
Accrual Accounting
Expense Recognition example 2
Making Advance Payments (prepayments)You prepay an employee in February $1000 for his March salary
In this case the business cannot record the $1000 as a salary expense in February since the expense has not been incurred yet
The business records a service claim from the employee
Once the employee works for the month of March it may record it in its books as a salary expense
Cash & Accrual Accounting
February March
ServicesReceived
$$
Paymentmade
Record Expense $$
Yiannis Megaloeconomou, MBAJoin my Udemy Course (link)
Cash Accounting - Advantages
1. Easy to use due to its simplicity and less regulation
to follow
• Since it’s based only on cash transactions
2. It keeps a good record of cash transactions
• Inflows and outflows from operations
3. Good for businesses that do not operate on a credit
basis
• They receive and pay within the same period
their revenue and expenses respectively
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
Cash Accounting - Disadvantages
1. It does not record receivables
• E.g. If you deliver goods to a customer in
January and the agreement is to receive
payment for these goods in February, at the
end of January there is no accounting record
of the money that you expect to receive from
the customer in February
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
2. It does not keep track of payables
• E.g. If you receive goods in January from
a supplier and you agree to make
payment of these goods in February,
there is no record in the books of this
obligation that you have to meet in
February
Cash Accounting - Disadvantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
3. It does not track partial payments
• Let’s say you have agreed to receive
payment from a customer in three
installments, $1000 in January, $1000 in
February and $1000 March. At the end of
January, there is no accounting record
saying that two payments of $1000 are
still expected to be received in February
and March, since cash accounting does
not keep track of the receivables for the
following two months
Cash Accounting - Disadvantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
4. There is no matching of expenses and their related
revenue during the same period
• E.g. An advertising agency works on a marketing project
for a customer for the entire month of January. All
expenses for the agency’s marketing project amount to
$1000 and are paid in full by the end of January. The
project is submitted to the customer by the end of January
at a sales price of $2000. However, payment is received in
February.
• The project’s expenses of $1000 will be recorded in
January and its $2000 of sales revenue in February
• Therefore, there is no match of the revenue and their
related expenses during the same period
Cash Accounting - Disadvantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
5. Operations and results are not
accurately recorded
• Let’s say you sell and deliver goods to a
customer in February at a sales price of
$2000. Payment for the these services
(operations) is received in March.
• The actual operations (services) took
place in February but sales (results) are
recorded at a different time period in
March
Cash Accounting - Disadvantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
Accrual Accounting - Advantages
1. It keeps track of receivables
• For example when services are provided to a
customer on credit you record both sales
revenue and customer’s expected payments
(receivables)
2. It records payables
• When a business buys goods on credit from a
supplier, it keeps a record of its liability
(payables) to its supplierCash & Accrual Accounting Yiannis Megaloeconomou, MBA
3. It keeps track of partial payments
• Let’s say you have agreed to receive
payment from a customer in three
installments, $2000 in January, $2000
in February and $2000 March. At the
end of January, there will be an
accounting entry stating that two
payments of $2000 each are still to
be received in February and March
Accrual Accounting - Advantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
4. It keeps reports of cash
transactions
• Since it records both cash and
non-cash transactions, such as
receivables and payables
Accrual Accounting - Advantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBAJoin my Udemy Course (link)
5. It matches expenses and their related
revenue • E.g. An advertising agency works on a marketing
project for a customer for the entire month of
January. All expenses for the agency’s marketing
project amount to $1000 and are paid in full by the
end of January. The project is delivered to the
customer by the end of January at a sales price of
$2000. However, payment is received in February.
• The marketing project’s expenses of $1000 and also
sales revenue of $2000 will be recorded in January
since it tracks expenses and revenue at the time of
service
Accrual Accounting - Advantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
6. Operations and results are accurately
recorded• Let’s say you sell and deliver goods to a customer
in February at a sales price of $2000. Payment
for the these services (operations) is received in
March.
• The actual operations (services) and sales
revenue (results) are recorded at the same time
since both took place in February
Accrual Accounting - Advantages
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
Accrual Accounting - Disadvantages
1. It is a more complex accounting methods
since it goes far beyond cash
transactions
2. It’s subject to more rules and regulations
since it necessitates some estimations
• For example, a business needs to estimate
some expenses such as depreciation
expenses, receivables that will never be
collected, etc.Cash & Accrual Accounting Yiannis Megaloeconomou, MBA
Things to Remember
• Cash & Accrual Accounting are 2 different
methods for recording sales revenue &
expenses
• Usually small and medium size businesses use
cash accounting while larger businesses apply
accrual accounting
• Each method uses a different approach,
however accrual accounting makes more
business sense since it matches much better
operations with revenue and their associated
expenses during a periodCash & Accrual Accounting Yiannis Megaloeconomou, MBA
Access 3+ hours of Videos+ Practice Problems.
Join my Udemy Course http://goo.gl/3CvsqC
http://goo.gl/3CvsqC
Practicing
For practice there are available problems to
download on cash and accrual accounting
along with their solutions
Cash & Accrual Accounting Yiannis Megaloeconomou, MBA