| Cash basis Cash-basis accounting is a
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| | details of the actual cash flows and
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| method of bookkeeping that records
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| | their timing are tracked by bookkeeping.
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| financial events based on cash flows and
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| | Comparison Using cash-basis accounting,
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| cash position.
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| | income and expenses are recognized only
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| Revenue is recognized when cash is
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| | when cash is received or paid out.
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| received and expense is recognized when
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| | Using accrual-basis accounting,
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| cash is paid. In cash-basis accounting,
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| | receivables and payables are recognized
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| revenues and expenses are also called
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| | when a sale is agreed to, even though as
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| cash receipts and cash payments.
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| | yet, no cash has been received or paid
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| Cash-basis accounting does not recognize
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| | out.
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| promises to pay or expectations to
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| | Cash-basis accounting defers all credit
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| receive money or service in the future,
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| | transactions to a later date. It is more
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| such as payables, receivables, and
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| | conservative for the seller in that it
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| prepaid expenses.
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| | does not record revenue until cash
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| This is simpler for individuals and
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| | receipt. In a growing company, this
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| organizations that do not have
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| | results in a lower income compared to
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| significant amounts of these
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| | accrual-basis accounting.
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| transactions, or when the time lag
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| | A simple example A small business such as
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| between the initiation of the transaction
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| | a fruit stand, which buys its inventory
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| and the cash flow is very short.
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| | daily for cash at a wholesale market,
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| Two types of cash-basis accounting exist:
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| | sells the inventory for cash, and throws
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| strict and modified. Strict cash-basis
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| | away what didn't sell, can get an
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| follows the cash flow exactly.
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| | accurate picture of its profits or losses
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| Modified cash-basis includes some
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| | using cash-basis accounting.
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| elements from accrual-basis accounting
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| | A remodeling business that gives
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| such as inventory and property
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| | customers 90 days to pay and that
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| capitalization.
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| | procures materials on account at the
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| Issues with cash basis Cash-basis
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| | lumber yard, must use the accrual method
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| accounting fails to meet GAAP
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| | to gain an accurate picture of its
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| requirements because it does not adhere
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| | financial condition.
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| to the following two GAAP principles:
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| | Either business will probably get a
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| Revenue recognition principle - revenue
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| | relatively accurate picture using either
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| should be recognized when it is realized
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| | method over a long period of time, except
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| (e.g. a credit sale) Matching principle -
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| | for the transactions that have already
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| revenue should be matched to the expense
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| | begun that are not yet closed.
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| if possible (e.g.
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| | Other considerations Standard
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| sales to COGS) Additionally, cash-basis
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| | accrual-basis financial statements
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| accounting is not viable for cost
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| | (profit statements and balance sheets) do
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| accounting in manufacturing operations
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| | not indicate the cash inflows and
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| because expenses cannot always be
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| | outflows of a company. The Statement of
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| correctly associated with product costs.
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| | Cash Flows is created to indicate that
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| Example When you pay your rent, your
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| | information for accrual-basis accounting.
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| landlord would record an income event at
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| | Accrual-basis accounting is more costly
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| the time he receives your payment. The
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| | to maintain, because it requires the
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| landlord would subsequently record an
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| | bookkeeper to record a lot more
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| expense event when he pays the rental
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| | transactions. However, the advent of
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| agent their fee for your apartment. It is
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| | accounting software has made the
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| the accounting method used by most
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| | difference between the reporting methods
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| individuals, and by some businesses, that
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| | less significant.
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| have limited payables or receivables or
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| | Companies that have extended or used
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| whose income and expense cash flows are
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| | credit significantly should use (and in
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| closely associated with each other in
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| | the United States may be required by the
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| time.
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| | Internal Revenue Service to use) the
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| Accrual basis Accrual-basis accounting
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| | accrual-basis method of accounting. The
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| records financial events based on events
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| | U.S. Securities and Exchange Commission
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| that change your net worth (the amount
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| | requires that all publicly traded
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| owed to you minus the amount you owe
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| | companies follow GAAP, thus all publicly
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| others).
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| | traded companies publish their financial
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| Standard practice is to record and
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| | statements using accrual-basis method.
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| recognize revenues in the period which
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| | Three kind of external stakeholders
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| they incur and to match them with related
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| | should be considered when deciding the
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| expenses in a process known as matching
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| | reporting method: creditors stockholders
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| or expense matching. Even though cash is
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| | taxation authorities For the creditors
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| not received or paid in a credit
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| | and stockholders of large enterprises,
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| transaction, they are recorded because
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| | cash basis accounting is financially
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| they are consequential in the future
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| | inadequate. It does not project the
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| income and cash flow of the company.
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| | future cash flow of the company.
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| Accrual-basis is GAAP compliant.
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| | For tax purposes, cash basis accounting
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| Example Your landlord would record an
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| | is highly favored because it defers tax
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| income event on the day your rent comes
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| | burdens until the cash is received. It is
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| due (you owe it to him). He records an
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| | often used by small businesses and
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| expense event when the fee owed to the
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| | organizations that are not required to
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| rental agent comes due for your apartment
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| | use the accrual method, both for tax
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| that month (he owes it to the agent). The
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| | reasons and for its simplicity.
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