Accounting Method
An accounting method refers to the rules a company follows in reporting revenues and expenses. The two primary methods of accounting are accrual accounting (generally used by companies) and cash accounting (generally used by individuals).Cash accounting reports revenues and expenses as they are received and paid through cash inflows and outflows; accrual accounting reports them as they are earned and incurred through sales and purchases on credit and by using accounts receivable & accounts payable. Generally accepted accounting principles (GAAP) requires accrual accounting.
Accounting Methods
Definition: Accounting methods refer to the rules that a company follows in reporting its income and expenses. The two main methods of accounting are accrual accounting and cash accounting.
Origin: The origin of accounting methods can be traced back to ancient civilizations, but the development of modern accounting methods mainly occurred in the 19th and 20th centuries. The distinction between accrual and cash accounting became clear in the early 20th century and has been widely applied in modern accounting standards.
Categories and Characteristics:
- Accrual Accounting: Accrual accounting reports income and expenses by recording credit sales and purchases, as well as accounts receivable and accounts payable. This method provides a more comprehensive view of financial status, is typically used by companies, and complies with Generally Accepted Accounting Principles (GAAP).
- Cash Accounting: Cash accounting reports income and expenses through cash inflows and outflows. This method is simpler and is usually used by individuals or small businesses because it is easier to manage and understand.
Specific Cases:
- Case 1: A large manufacturing company uses the accrual accounting method to record its financial activities. The company records revenue when products are sold, even if the customer has not yet paid. This allows the company to more accurately reflect its financial status and operating results.
- Case 2: A small retail store uses the cash accounting method. The store records revenue only when cash is actually received and records expenses when bills are paid. This method allows the store owner to manage cash flow more intuitively.
Common Questions:
- Question: Why do most companies use accrual accounting instead of cash accounting?
Answer: Accrual accounting provides a more comprehensive and accurate view of financial status and complies with Generally Accepted Accounting Principles (GAAP), making it more suitable for large companies and complex businesses. - Question: Can individuals or small businesses use accrual accounting?
Answer: Yes, but because accrual accounting is more complex, individuals and small businesses typically prefer to use cash accounting.
