Accounting Method and its Types
Accounting Method Defined
A decision face by a new business is what accounting/bookkeeping method is going to be used to track revenues and expenses.
An accounting method is just a set of general rules, which are used to decide when to report the expense and income.
If you business’s major part is inventory, then the Internal Revenue Service (IRS) made decision for the business owner. There are two accounting methods.
- Accrual method
- Cash method
Some business requires to use the accrual method while some required to use cash basis method.
It is important to mention here that the name of the method such as accrual method or accrual basis are interchangeable, like wise cash method and cash basis are also interchangeable, so do not worry or become confuse in the names. They both refer to the same concept.
The Cash Method identifies revenues in the period, the cash is received and expenses in the period, when the cash are paid.
Cash Method split into two types methods exist:
- Strict Cash Method (Basis)
- Modified Cash Method (Basis)
A strict Cash method follows the cash flow exactly.
A modified cash method is mix-up of the accrual method, and which provides some special features in order handle items like an inventory and cost of goods sold, liabilities and payroll tax expenses, and it also to record the depreciating property and equipment.
Mostly small business use modified cash method, whether they know its feature or not.
By concentrating on recording revenues and expenses, the purpose of the cash modified cash method of accounting is on determining the net income or loss for a period based on the cash received and the cash spent.
Information, such as the amounts billed to customers for products and/or services and not paid, and the amounts billed by supplier for their products and/or services and not paid is not normally recorded and maintained using the cash method in the “books”.
Initially, most of small business start their business using the cash basis instead of the accrual method.
Because generally accepted accounting principles (GAAP) do not considered to be in conformity with the use of the cash method.
In most of cases, the audited statements are only required for the “big fish” (companies who publicly trade the ownership interests). The “little fish” like the baby shops do not need to worry. Yet, if possible, a business may consider using the accrual method of accounting.
The accrual method or basis of accounting records income in the period earned and records expenses and capital expenditures such buildings, land, equipment, and vehicles in the period incurred.
The purpose of accrual method of accounting is to properly match income and expenses in the correct period.
In order to achieve, the accrual method records revenue as earned when the product or service is shipped and invoiced to the customers. Similarly, the expenses and the capital expenditures are also recorded as acquired when the product or service is transported and billed by the supplier.
Information, such as the amounts billed to customers for products and/or services and not paid, and the amounts billed by supplier for their products and/or services and not paid is also recorded and maintained in the “books” using the accrual method.
These are the accounting method required to be used to follow the generally accepted accounting principles (GAAP) for preparing financial statements for external users.
We will discuss generally accepted accounting principles (GAAP) in later posts.
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