The Advantages of Accruals Accounting

As seen from the examples above the accrual accounting is more accurate in terms of assessing financial position of company since it matches income with the expenses incurred to produce it. It allows financial managers to measure company’s performance with more realistic figures. In cash accounting, financial statements may be showing positive cash flows even if company may be going broke because of the expenses which have been accrued but not yet paid. Therefore accrual accounting is much safer as a measurement tool over cash accounting.

As the complexity of business transactions increased, the need for more accurate financial information led the financial managers to move from cash accounting to accruals accounting.  The companies which sell their products and services on credits or have projects that provide cash flows not just for current period but over a long term have been struggling to see their financial position. The accruals accounting is able to overcome these problems by combining current and future cash flows in the same financial statements.

Accruals accounting also allows more effective comparisons against other financial institutions which are using same accounting principle or industry standards.

Apart from the timing differences of transaction recording, in the accruals reporting, followings are treated differently:

Superannuation

Superannuation is the pension, which companies or governments are liable to pay to employees upon their retirements. They are usually made through trust funds. Accruals accounting records superannuation liabilities whether they are funded or unfunded. Also the number of employees, assumptions on wages growth, inflation and expected rate of return on investments are taken into account while calculating changes in the stock of unfunded liabilities.

Depreciation

Accrual accounting records cost of capital investment across the life of asset as depreciation, whereas cash accounting records this capital expenditure in a given fiscal year.

Public Debt Interest PDI

Under cash accounting PDI is recorded as the interest paid during the year. Under an accrual approach, allowance is made for interest accrued, but not actually paid, during the period.

Taxation Revenue

When revenue is accrued at the time of economic transaction, company becomes liable to pay tax on this revenue whether it is earned or not. Therefore very consistent and reliable method for accrual estimations is needed. However it is very difficult to know when all such transactions occur. As a result, it’s been put into practice that the revenue is only recognized as accruing when the relevant law indicates the existence of requirement or the taxpayer makes a self assessment.

The advantages of accruals accounting can be summarised as below:

  • Improved accountability and better financial management.
  • Reflects full scope of company’s resources (all assets), obligations (all liabilities) and costs (resources consumed).
  • Provides more focus on the business output rather than input.
  • Helps financial managers to use company resources more efficiently.
  • Establishes a better link of resources and results yielded from these resources.
  • Full cost of product or services can be compared across industry standards.

3 comments:

Parris Moretti said...

Accrual accounting is one of the best methods for preparing financial statements. Often, large companies are required to use accrual accounting method to report financial information for stakeholders. Small business can also use this method of accounting. Accrual methods lists income as the company earns it, not when they receive it. It also treats accounts receivable as an asset and allows the report to print with other periodic financial statements.

aliah said...

accrual accounting method provides a information of the financial reality of a company. this accrual accounting method accounting method helps to compare performance and stability from one report to the next.
Business Accountant

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