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Hi, and welcome to part three
of Cash vs. Accrual Accounting
in this HSTalks series
on Analyzing Financial Statements.
My name is Dr. David Bond.
In this part,
we'll explore the differences
between cash and accrual accounting
as well as the four main situations
which require adjusting entry.
0:20
A quick recap from part two
is that one of the main purposes
of an accounting information system
is to generate
a set of financial statements
based on the business activities
of the entity.
Of particular interest to users
is the net profit of the entity,
which is calculated by taking
revenues and subtracting expenses.
0:38
There are two different ways
in which an entity can record
revenues and expenses.
The first
is the cash basis of accounting,
the second
is the accrual basis of accounting.
The main difference between the two
is the timing of when revenues
and expenses are recorded.
Under the cash basis of accounting,
revenues are recorded
when cash is received
whilst expenses are recorded
when cash is paid.
Under the accrual basis of accounting,
revenues are recorded
when they are earned
whilst expenses are recorded
when they are incurred.
1:09
For example,
when you buy a ticket for a flight
on a commercial airline,
you pay for this in advance,
in some cases, many months in advance.
Let's assume
that on the 15th of January,
I pay $100 to purchase a ticket
to fly from Sydney to Melbourne one way.
The date of the flight
is the 12th of August.
Under the cash basis of accounting,
the airline would record $100
of revenue on the 15th of January
as that is when they received
the cash from me.
Under the accrual basis
of accounting however,
the airline would record cash
being received
on the 15th of January but no revenue.
They would only record
the revenue for the flight
on the 12th of August.
We'll look at the entries required
in more detail in a few moments.
The cash basis of accounting
is generally used
by small to medium enterprises
as it is less costly to prepare
financial statements this why.
For larger entities,
i.e., those using IFRS or US GAAP,
the accrual basis of accounting
is required.
