Why Every Accounting Firm Must Adopt Accrual System of Accounting

Cash System VS Accrual System of Accounting?

‘In a Cash system of accounting, you recognise income/expenses only when movement of cash is actually involved. Small businesses prefer a cash basis for accounting to show the accurate figures for the year. On the other hand in the accrual system of accounting, you recognize income at the time revenue is earned (need not be received in cash), or expenses when a liability has incurred and so on.’

Suppose, you sell a product worth $100 in May but receive the amount against the same in June. As per cash system you would record the sales in June but as per accrual system you have to show the sales in May itself. Considering a realistic operation, the number of transactions involved when running a business cannot be anticipated. But following such a system would show a fairer picture of your business operations and finances.

What are some benefits in following an Accrual System for your accounting?

Financial Planning:

• True and fair view of your business for both owner and stakeholders
• Forecasting finances with more accuracy
• Minimal differences with actual transactions helping in better planning of your resources
• Eases the budgeting process and cash flow management

You can use technology to automate your workflows of payables (AP) and receivables (AR). This increase the accuracy of the figures and cuts short on resources used, helping an owner to manage business much more efficiently.

More accurate:

• Stakeholders expect to see finances being depicted in their fairest form of any organisation they want to invest in.
• Following an accrual system makes your books more accurate and is the first step to reach this goal.
• This is why it is preferred that the accrual system is followed even when receiving funding from other financial institutions.

US GAAP Compliant

• Generally Accepted Accounting Practices (GAAP) requires you to follow an accrual system of accounting when reporting financial statements.
• This is accepted as a standard for reporting globally. You can read more about this here - Financial Accounting Standards Board (FASB).
• This becomes crucial when you want to scale your business and planning for it beforehand makes it easier.
• Investors also consider this as important when planning to invest in your firm.

Tax Benefits

• As a business owner you might be familiar with ‘deductible expenses’. It’s the set of eligible expenses that can be reduced from the profit that you need to report to the tax authorities.
• This helps in reducing the tax you need to pay to the authorities.
• In the accrual system, you will be recording the expenses at the time of the liability occurring.
• This helps in utilising tax benefits on such expenses in the year itself and helps in better tax planning.

What are the cons of the Accrual System?

There are a few cons to the accrual system that mainly stem at the time of implementation. With a few simple measures of control and the help of experts, these can be minimised.

Prone to fraudulent reporting

as transactions are recorded when it’s due without actual involvement of cash. Owners manipulating incomes and expenses is a loophole. Experts

Here, stating the incomes or expenses as per the interest of the owner is the gap where an expert should ensure proper controls. (?)

Transition

from cash accounting to the accrual system can be a tedious process considering the scale of your existing business. Things like cash flow will have to be looked into carefully to ensure transparency and accuracy in the books.

Requires help of experts

in your team to ensure that the books are representing a true picture of your business. Following an accrual system will need thorough understanding of how your business revolves around transactions, in-depth knowledge of your spends, accurate estimation of future transactions and so on.