Advantages and Disadvantages of Accrual Based Accounting
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We have collected some solid points that will help you understand the pros and cons of Accrual Based Accounting in detail.
But first, let’s understand the topic:
What is Accrual Based Accounting?
Accrual Based Accounting is an accounting method that records revenues and expenses when they are incurred, rather than when cash is exchanged.
What are the advantages and disadvantages of Accrual Based Accounting
The followings are the advantages and disadvantages of Accrual Based Accounting:
|Accurate Financial Reporting||Difficulty in Tracking Cash Flow|
|Better Management of Cash Flow||Complexity in Record Keeping|
|Precise Record Keeping||Confusion with Tax Rules|
|Improved Accountability||Outdated Information|
|Better Tax Planning||Lack of Flexibility|
Advantages of Accrual Based Accounting
- Accurate Financial Reporting – Accrual based accounting helps companies maintain accurate financial records. It allows them to match their income and expenses in the right periods so that their financial statements reflect the true financial condition of the company. By doing so, it enables investors, lenders, and other stakeholders to make sound financial decisions.
- Better Management of Cash Flow – Accrual-based accounting enables businesses to keep track of their cash flow better. It allows companies to predict future cash flows and plan for any potential deficits or surpluses that may arise. This, in turn, helps them avoid cash shortages and make informed investment decisions.
- Precise Record Keeping – Accrual-based accounting provides a more precise and detailed record of business transactions. Since it records income and expenses when they are earned or incurred, it eliminates any doubt or ambiguity in financial transactions. This is essential when companies face audits or when they need to provide accurate financial statements to stakeholders.
- Improved Accountability – Accrual-based accounting promotes greater accountability among businesses. By recording all financial transactions, companies can better monitor and control their expenses. This helps them avoid overspending and better manage their budgets. It also fosters transparency in financial reporting and creates trust among stakeholders.
- Better Tax Planning – Accrual-based accounting can help companies plan their tax payments more efficiently. It allows them to record expenses before they are paid and claim tax deductions for those expenses in the same period. This helps companies minimize their tax liability and maximize their profits.
Disadvantages of Accrual Based Accounting
- Difficulty in Tracking Cash Flow – Accrual-based accounting can make it difficult to track cash flow. Since it recognizes income and expenses when they are earned or incurred, it may not match up with when cash is actually flowing in and out of the business. This can make it challenging for businesses to monitor and manage their cash balances accurately.
- Complexity in Record Keeping – Accrual-based accounting can be difficult to manage as it requires a lot of record-keeping effort. A company may have to keep track of many accounts and reconcile them regularly to ensure the accuracy of the financial statements. This can lead to errors if not done correctly, and can be time-consuming.
- Confusion with Tax Rules – Accrual-based accounting can be complex when it comes to tax payment. Since it records income and expenses when they are earned or incurred, a company may have to pay tax on income that has not yet been received. This can be confusing in estimating future tax liabilities and deciding when and how much to pay in taxes.
- Outdated Information – Accrual-based accounting can provide outdated financial information. Since it records transactions when they are earned or incurred, it may take some time before the transactions are recorded. This can lead to financial statements that do not reflect the current financial position of the company.
- Lack of Flexibility – Accrual-based accounting lacks flexibility in terms of adjusting your financial statement. You cannot adjust a transaction that has already been recorded, which makes correcting the mistake very difficult. It can also be a challenge for businesses to change their accounting methods once it has been implemented.
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