Required under the Generally Accepted Accounting Principles (GAAP), accrual basis accounting is an approach that attempts to simulate the economic reality of the activities of a business, rather than simply recording transactions as they take place. This method is a given for a large company, but for a small one, it may not be that beneficial. To determine whether accrual basis accounting is appropriate for your business or not, it is best to understand the advantages and disadvantages that come with it.
List of Advantages of Accrual Basis Accounting
1. It grants more useful business analysis.
The matching of expenses and revenue using this method allows you to conduct more useful business analysis. For instance, when you purchase expensive machinery to be used over the next decade, its cost will be spread over such a period. Just as this time frame will see some benefits of the equipment, each year in the period will also get some of the expenses through the revenue gained from selling products the machine has produced.
2. It allows for easy planning.
One process that will become easier with accrual basis accounting is planning, especially that it allows you to account for all of your expenses and revenue within the right period. This entails that you will be able to create budgets for your expenses and predict sales, which is essential to inventories, staffing and other areas of operation. Aside from easier planning, this accounting method can help with reducing your tax burden by issuing invoices at the start and the end of the year.
3. It is compliant with GAAP.
With expenses and revenue matched, accrual accounting allows for financial statements that are unaffected by cash timing in business negotiations. Basically, this will make periodic financial statements to become more representative of your business’s health, rather than what the checkbook shows. While not all small business are required to be compliant with GAAP, they will be in the future if they plan to expand to outside investors.
List of Disadvantages of Accrual Basis Accounting
1. It poses some difficulties.
Difficulty is one huge drawback of accrual basis accounting, where rules in the recognition of revenue and expenses can be very complicated. Now, if you want to fully and record transactions in your small business in accordance with GAAP, you should seek the help of an accountant.
2. It can lead to deception.
It is important to note that the confusion coming with this accounting practice can lead people to deception of financial statements. For example, some businesses have misused the method to hide weaknesses and mistakes within their financial reports. Simply put, it can be used to hide fraud.
3. It is difficult to switch costs.
If you have started with another method of accounting, it can be difficult to switch to the accrual basis. This is because you might already be having difficulties with cash-flow at the start, which is why most start-ups go for cash basis accounting.
Of course, accrual basis accounting can be beneficial when implemented properly. By understanding the advantages and disadvantages that come with it and discussing them with your accountant, you can determine whether it is best to implement in your business or not.
Natalie Regoli is our editor-in-chief. The goal of ConnectUs is to publish compelling content that addresses some of the biggest issues the world faces. If you would like to reach out to contact Natalie, then go here to send her a message.