Application of Accrual Accounting †Free Samples to Students

Question: Discuss about the Application of Accrual Accounting. Answer: Introduction: The key users of the financial reporting are potential and present investors, creditors and lenders, who make use of this information in making their decisions as to whether they should purchase, hold or sell equity and providing or settling some financial loans. The key statements in an organization are statement of comprehensive income, cash flows statement, balance sheet as well as statement of shareholders equity (White, Braentner Towery, 1993). In this case, this section would concentrate on statement of comprehensive income and would present its purpose to users. Statement of comprehensive income is usually the report an organization financial performance is presented. It helps in providing summary on how an organization incurs sales and expenses via both the non-operating and operating activities. It is usually divided into non-operating as well as the operating section with the operating section disclosing info on proceeds and operating expenses which are openly resulting from organization regular operations (Kakani, Ramachandran Chatterjee, 2010). On the other hand, non-operating portion helps in disclosing revenues and expenses on activities which are not related directly to an organizations operations. Interestingly, the primary users of the financial information are therefore in need of income statement in assessing the organizations prospects for the future net cash inflows and also in assessing how efficiently and effectively management could be discharging their responsibilities in utilizing organizations existing resources (Kothari Ball, 1994). Statement of comprehensive income or the income statement is very important in providing relevant information to different user on financial performance or health of a given firm over a specific accounting period (Zack, 2013). As financial performance is usually concerned with profitability of an organization, users require information on organizations financial performance in order to evaluate probable changes or variation in its economic capital as well as its ability to generate some cash from all its resources. In addition, statement of the comprehensive income is crucial for different user in evaluating how efficient any extra resources could be utilized in an organization. Further, statement of comprehensive income is useful since it displays how much cash an organization made within a defined period. Another purpose of statement of comprehensive income is that the statement helps in determining whether an organizations earning are sufficient in repaying its loans. In addition, statement of comprehensive income is crucial in highlighting some of the weaknesses and strengths in an organization over a given period of time (Kakani, Ramachandran Chatterjee, 2010). Statement of comprehensive income is also crucial since it shows readers and financial users how much loss or profit an entity generated within the reporting period. Such information is crucial when statement of comprehensive income from numerous period are all put together, such that trends in revenue and expenses is viewed. In addition, given that statement of comprehensive income gross profits is usually gotten by netting sales and cost of the goods sold, the information contained in this statement provide a signal of the capacity of the firm in setting price points which clients could easily accept and in maintaining costs of products and services which it offers. Further, statement of comprehensive income is crucial for investors since it help them evaluates the consistency of profit which proves viability of an organization (Kothari Ball, 1994). It is also help lenders in evaluating the probability of an organization to generate adequate income in paying off its interest expenses. Income in the statement of comprehensive income is the total amount received after deducting all the operating expenses, taxes and interest expenses for the financial obligations. In essence, income is the amount of money an organization generates by providing services or selling products. An example of income is the discounts or negotiating rebates with the venders. According to the conceptual framework, income is the increase in the economic benefits within an accounting period in form of the inflows or enhancements of the assets or declines of the liabilities which result in rise in equity, other than the items relating to the contributions from the equity participants. Expenses on the other hand are total amount of expenditures incurred by an organization while conducting its normal production or selling operations (Zack, 2013). This is the total amount of money incurred or spent in an entitys effort for generating expenditures representing cost of conducting a business. These range from salaries of the employees to office suppliers, cost of gods sold to material expenses. They might also be form of cash payment, amount taken from earnings such as bad debts as well as depreciation (Kakani, Ramachandran Chatterjee, 2010). In conclusion, statement of comprehensive income is usually the report an organization financial performance is presented. It helps in providing summary on how an organization incurs sales and expenses via both the non-operating and operating activities. Further, the statement of comprehensive income or the income statement important since it provides relevant information to different user on financial performance or health of a given firm. It is also since it helps in evaluating how efficient any extra resources could be utilized in an organization. In addition, it assists in determining whether an organizations earning are sufficient in repaying its loans. General Purpose of Statement of Financial Position The statement of the financial position is the financial statement that grants financial health or soundness of an organization. It comprises of three primary elements, liabilities, equity and assets. Statement of Financial position is said to be very important since it highlights financial standings of an organization at specific period (Zack, 2013). In addition statement of the financial position comprise of liabilities, equity and assets. This is crucial as it assist users of the financial statement is assessing or evaluating financial healthy or soundness of an organization in terms of financial risk, business risk, liquidity risk as well as credit risk. While assessing or evaluating an organization over a longer period, this statement assists in identification of underlying trends in financial position of an organization (Accounting-simplified.com, 2017). Thus, statement of the financial position is significant for readers in determining state of an organizations level of risk. In addition, when used with other statements, the statement might assist in identifying trends and relationship that are indicative of probable issues or areas that require further improvements. Therefore, statement of financial positions has wide purpose as it assist users in predicting amount volatility and timing of an organizations upcoming incomes. Generally, statement of the financial position is crucial in that it inform readers on the current status of an organization where this information is then utilized in predicting or projecting liquidity, debt position and funding of an organization. Assets are those resources an organization controls or own at a provided period. In addition, assets are resources owned by an organization to assist it in deriving some economic benefits from their use. There are two different types of assets; non-current and current assets. Current assets comprises of cash as well as inventories, cash equivalent, account receivables, as well as the prepaid expenses. These are assets that could deliver economic benefits to an organization within a year. They are those resourced expected to be loaned out, consumed, sold or leased in creating some income within a year of balance sheet date (Kothari Ball, 1994). On the other hand, non-current assets comprises of assets that cannot be easily or quickly transformed into cash. These include property and equipment, land, furniture, vehicles, buildings, fixtures and others. In essence, non-current assets are those assets that deliver economic benefits to a given firm over a long period (White, Braentner T owery, 1993). These are resources not recoverable, meaning that the monetary value of such resources is extracted from these resources is no longer important, till over one year past balance sheet period. These can also be classified as intangible and tangible assets. In this case, those amounts of assets with some physical substances are usually categorized as the plant, property and equipment while those one that do not have physical material are usually categorized as the intangible assets. Liability on the other hand represents the total amount an organization owes others. In essence, liabilities are the financial obligations which an organization owes to other individuals or organizations and its repayment comprises of transfer of the cash or any other resources (Zack, 2013). In this case, liabilities comprise of two main parts; that is, current and non-current liabilities. Current liabilities are those obligations an organization is required to repay within one year which includes note payables, current maturities debts, bank overdraft, account payables and accrued expenses. In essence, these are financial obligations in an organization that could be settled over short-term (Ou Penman, 1989). On the other hand, non-current liabilities are those obligations which become due within one year or more. These include mortgages, long-term note payables, long-term loans, bonds and others. Basically, these are financial obligations that are to be settled over long-term. Equity represents what shareholders or the owner of an organization owns. It is usually a type of liability since it represents finances owned by an organization to owners or shareholders. In essence, equity is the resources an organization owes to owners or shareholders. They are usually derived by subtracting liabilities from its assets. Hence, signifies residual interests in an organization which goes to proprietors. They are usually offered under share capital which presents amount that needs to be reinvested by shareholders in an organization (Sinha, 2012). Secondly, they are presented under retained earnings which comprises of total income in an organization after distribution to owners in dividends. They are also presented as revaluation reserve which comprises of net spare of mounting reassessment of plants, property or equipment recognized straight in equity. Equity for the sole traders is quite different from the limited companies. This is evident by the fact that equity se ction in a sole trader is simple as compared to limited companies. In conclusion, statement of the financial position is the financial statement that presents financial position of a given organization. This statement is found to be very crucial since it highlights financial position of an organization at specific point in time. It is also crucial since it assist users of the financial statement is assessing or evaluating financial healthy or soundness of an organization in terms of financial risk, business risk, liquidity risk as well as credit risk. Thus, it can be concluded that statement of the financial position is significant for readers in determining state of an organizations level of risk. Accrual Basis of Accounting under GAAP GAAP are mainly mutual accounting values, procedures and standards which an organization has to follows whenever they compile the financial reports. It is usually the mixture of the commanding values and generally accepted means of reporting and recording accounting info. It usually improves clarity of communicating financial information (Guthrie, 1998). In addition, GAAP ensure minimum level of consistency in financial statement, which in turn makes it a bit easier for the potential investors to extract and analyse useful financial information (Scott, 1941). With these considerations, there is need to evaluate accrual basis under GAAP and why it takes place. Accrual basis of the accounting is usually the concept or process of recording sales when earned as well as expenses as they are incurred (Roje, 2006). This accounting concept is different from cash basis where revenues are usually recorded whenever cash is received and the total expenses are only recorded once cash has been paid (Lapsley, Mussari Paulsson, 2009). For instance, an organization operating under accrual basis would record its revenues soon as it issues invoice to its clients. Accrual basis is usually advocated under the IFRS and GAAP. Both of these frameworks offer guidelines on how to account for expenses and revenues in absence of cash payment or receipts (Dechow, 1994). In essence, accrual basis offer more even recognition of the expenses and revenues over time, and is therefore considered by potential investor as the most valid accounting concept for ascertaining outcomes of financial position, cash flows and operations of an organization. Basically, accrual basis mainly support matching principles of GAAP under which the related expenses and revenues are recorded within same reporting period, where by it is make possible to view full extent of losses and profit linked with particular organization transaction within a specific reporting period (Blndal, 2003). On the other hand, accrual basis is also said to support revenue recognition principle which state that income statement has to reflect true extent of the revenue earned within the period it is earned irrespective of whether the money from such transaction is received or not. This implies that revenue is recognized only when seller transfer all the risks to the buyer. Further, based on historical cost concept, revenue is based on the past proceedings and it needs consistency as well as comparability which require transaction to be recorded at historical costs. In this case, revenue is not recognized as increase in the asset value except where it is required or allowed by the accounting s tandards. Finally, time period concept principle, revenues are only reported or recognized over standard period of time, which could be monthly, or annually. Once the period has been established, transactions are then recorded within a given or set period. In conclusion, accrual basis usually needs an organization to record all its transactions during the period when a financial event takes place. Therefore, in case GAAP utilized cash accounting, the transactions could not be recorded for some time after a product leaves the inventory. In essence, accrual basis is crucial and thus the reason why GAAP make use of the accrual basis since it provide accurate reporting in between the period. In addition, accrual basis usually carries matching principle in between the expenses and revenues, which is a significant component for the GAAP. References Accounting-simplified.com. 2017, Statement of Financial Position [Balance Sheet]; Viewed at 12th May 2017 from: https://accounting-simplified.com/financial/statements/statement-of-financial-position.html Blndal, J. R. (2003). Accrual accounting and budgeting.OECD Journal on Budgeting,3(1), 43-59. Dechow, P. M. (1994). 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