Before going into details about how to solve problems associated with annual cash basis one needs to understand what cash basis stands for.
What is cash basis?
Cash basis stands for one of the major accounting methods that identify expenses as well as revenues during the payment and receipt of cash. The other accounting method is the accrual method which is completely different from the idea of cash basis. Unlike cash basis method, in case of accrual accounting, the revenue is noted when it is earned but not necessarily during the physical exchange of the cash. For further details, you need to take a look at annual cash basis homework answers.
One of the major disadvantages of maintaining an annual cash basis is that it is less accurate than accrual accounting. This is because the cash basis is updated only once the cash is exchanged physically and thus takes time to reflect the change in the company’s book.
Cash basis versus accrual accounting
The major difference between the two is the time of recognition of revenue and expenses. The annual cash basis method is mostly useful for personal accounting and small firms. The cash basis method recognizes the revenue only when the cash is received and the expenses when the cash is paid off.
In contrast to this, the accrual method recognizes revenue whenever it is earned and expenses when they are incurred. Between the two the accrual method is more commonly used. Cash basis is usually used by sole traders and for personal financing. It is not advisable to use the cash basis method in case of large firms as these do not update the accounting book on a real time basis.
Example:
Let’s go through an example to understand this in a better way.
Say a company owns a business of selling cars. If the company sells a car worth $30,000, using the cash method, the amount is not recorded in the book until and unless the cash is fully received by the company whereas in case of accrual accounting method the amount is noted in the books once the sale is confirmed.
Limitations of cash basis:
Certain businesses are not allowed to use the cash basis method of accounting. These include partnership business where at least one partner is not self-employed and uses the profit averaging election.
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