PUBLIC FINANCE

Public Finance Questions

Table of Contents

Cash vs. Accrual basis2

Example 15

Example 26

Advantages of accruals accounting vis-à-vis cash accounting7

Advantages and disadvantages of the accrual method7

Advantages and disadvantages of the cash method8

Resource Accounting and financial reporting10

Managerial functions of resource accounting12

Public Organizational applications of HRA13

Bibliography15

Public Finance Questions

1. Identify the differences between cash accounting and accruals accounting.

Cash vs. Accrual basis

Accounting records prepared using the cash basis recognize income and expenses according to real-time cash flow. Income is recorded upon receipt of funds, rather than based upon when it is actually earned, and expenses are recorded as they are paid, rather than as they are actually incurred. Under this accounting method, therefore, it is possible to defer taxable income by delaying billing so that payment is not received in the current year. Likewise, it is possible to accelerate expenses by paying them as soon as the bills are received, in advance of the due date. The cash method offers several advantages: it is simpler than the accrual method; it provides a more accurate picture of cash flow; and income is not subject to taxation until the money is actually received.

Since the recognition of revenues and expenses under the cash method depends upon the timing of various cash receipts and disbursements, however, it can sometimes provide a misleading picture of a company's financial situation. For example, say that a company pays its annual rent of $12,000 in January, rather than paying $1,000 per month for the year. The cash basis would recognize a rent expense for January of $12,000, since that is when the money was paid, and a rent expense of zero for the remainder of the year. Similarly, if the company sold $5,000 worth of merchandise in January, but only collected $1,000 from customers, then only $1,000 would appear as revenue that month, and the remainder of the revenue would be held over until payment was received. (Accounting Standards Board, 2003 129)

In contrast, the accrual basis makes a greater effort to recognize income and expenses in the period to which they apply, regardless of whether or not money has changed hands. Under this system, revenue is recorded when it is earned, rather than when payment is received, and expenses recorded when they are incurred, rather than when payment is made. For example, say that a contractor performs all of the work required by a contract during the month of May, and presents his client with an invoice on June 1. The contractor would still recognize the income from the contract in May, because that is when it was earned, even though the payment will not be received for some time. The main advantage of the accrual method is that it provides a more accurate picture of how a business is performing over the long-term than the cash method. The main disadvantages are that it is more complex than the cash basis, and that income taxes may be owed on revenue before payment is actually received.

Under generally accepted accounting principles (GAAP), the accrual basis of accounting ...