Accrual Accounting Concepts

Accrual Accounting Concepts - Accrual Accounting Concepts...

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Accrual Accounting Concepts Accrual vs Cash Basis of Accounting Cash accounting – revenue is recorded only when the cash is received, and an expense is recorded only when cash is paid. Using cash based accounting is not suitable where business organisations conduct a major part of their business on credit, because the income statement produced will not truly reflect the activities that relate to the current period. Accrual based accounting – records transactions and events in the accounting period in which they occur rather than in the periods in which the entity receives or pays the related cash. Under the Framework for the Preparations and Presentation of Financial Statements, they require that the statement of financial position and the income statement be prepared on an accrual basis in order to best serve the function of providing relevant and reliable information for making decisions. For merchandising businesses – with accrual based accounting you record revenues when goods are sold rather than when the cash is received. Service businesses – record revenue when the service is performed rather than when the customer or client pays the cash. The accounting reports prepared using the accrual based system better reflect the true position and performance of the business for the period covered by the accounting period. Revenue Recognition Criteria Income is defined as both revenue and gains. Revenue – increases in economic benefits arising in the course of an entity. It includes sales revenues, fees, interest, dividends, royalties and rent. Gains - other increases in eco benefits. They are no different to revenue, only that they do not arise in the ordinary course of business – such as gain on sale of NCA. The operating cycle is the length of time it takes for businesses to acquire goods, sell them to customers and collect the cash from the sale. The question is at what point in the cycle should revenue be recognised? The revenue recognition criteria: It is probable that any future economic benefits associated with the revenue will flow to the entity The revenue can be measured reliably The concept of probability refers to the degree of uncertainty that the future eco benefits will flow to the entity. Expense Recognition Criteria The Framework defines expenses as encompassing both losses and expenses. Expenses – decreases in economic benefits. They include expenses that arise in the ordinary activities of the business such as COGS, wages and payments of rent Losses – expenses that do not arise in the ordinary course of the business such as the loss from a fire or flood.
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Expenses are decreases in equity during an accounting period that are not due to distributions to wonders.
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