FINANCIAL ACCOUNTING

Financial Accounting

Financial Accounting

Question 1)

A standard method of accounting in which income or expenses are accounted for when they occur, regardless of whether cash has been received or parted with, or even whether there is supporting evidence such as a bill or invoice. This might occur, for example, when gas charges have been incurred but no bill has been received yet. In such a case, the expense credit would be entered into the accruals account and the debit into the gas expenses account. The accruals basis of accounting is to be contrasted with the cash basis, in which transactions are accounted for when cash is received or expended. (Van den Berg, 2009)

As has already been stated, there were and continue to be a number of countries that have not adopted the accrual principle within their public sectors, and rather continue to conduct their budgetary activities according to the principles of the cash-based system. In the cash-based system, expenditure is deducted in full from the moment when the expenditure is made. A salary payment to a public servant for example would be deducted from the books and would thus effect the budget in the year and month that the payment took place. Similarly, payment for a road would be deducted in the budget at the moment that the expenditure took place. The difference between the salary payment and the expenditure for a new road is that the payment of wages would have to be paid again and again every month, unless of course the employee has stopped working, while alternatively the payment for the road is in principle a one-off expenditure, even though the road would continue to provide services for many years after the payment is made. The accrual principle allows the expenditures that are made today and that will provide benefits over a number of years to be deducted at small amounts over a longer period of time. The expenditure for a road for example would be included in the book-keeping at the time that the services of the road are used. Due to wear and tear, the road loses value over time and this reduction in value is described by a technical term: depreciation.

The system of depreciation and calculation of expenditure over time is common practice in the private sector, but this system is clearly also much more complicated than the cash-based system of accounting. How do you determine the rate of wear and tear for example and thereby also the yearly depreciation of goods? This is more difficult to calculate than the total cash expenditure that is made at the time the road is laid down. The cash expenditure is simply the concrete payment made to the contractor. (Pershing, 2011)

The accrual system provides very useful extra information that its user can draw upon in decision making - for example, whether it is financially better to buy or rent an office. In the cash system buying is always more expensive than hiring because the one-off purchase will be deducted ...