The Accounting Cycle

The difference between cash and accrual accounting is the accounting that is considered when reconciling journal entries. Hermanson, Edwards & Maher (1998) explain that in cash accounting, services rendered or goods sold are not considered revenue until payment is collected. This means that the revenue for the journal entry will be recorded as received. A good example of cash accounting is when a company sells goods in March 2017 but does not collect payment until May 2017. Therefore, in connection with this principle of accounting, earnings are recorded in May he received payment.

Table 1- Cash accounting

Activity

Month 1

Month2

Sales

-

$80,000

Employees salaries

$50,000

-

Income

$-50,000

$80,000

On the other hand, accrual accounting treats revenue entries as and when sales or expenses are incurred irrespective of when the payment will be done. Revenues will be recognized upon sales of goods or services, and the same applies to expenses as incurred by the organization (Hermanson, Edwards & Maher, 1998). For example, if an organization was to sell goods on credit so as to receive payments after two months, revenues will be recognized in the month of sale and not on the month of payment. It is the same for every expense the company realizes on credit.

Table 2 – accrual accounting

ITEM

Month 1

Month 2

Sales

$100,000

$120,000

Rent

$40,000

$40,000

Office expenses

$10,000

$10,000

Profit

$50,000

$70,000

A company needs to adjust entries in the general ledger for two main reasons. The first is to ensure that there is proper reporting of revenue and expenses (Hermanson, Edwards & Maher, 1998). Every entry has to reflect what kind of activity the business is undertaking, thus making it possible to differentiate between revenue and expense for the purpose of establishing whether the business is making profits or losses. The second reason is for the documentation of assets and liabilities. Every journal adjustment has an effect on the business financial statement, which indicates the kind of assets and liabilities a business has through its daily operations.

Reference

Hermanson, R.H., Edwards, J.D. & Maher, M.W. (1998). Accounting Principles: A Business Perspective, Financial Accounting (Chapters 1 – 8). New York: Richard D Irwin