Accounting Terms

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I know your father is now running a company and he needs to prepare financial statements for this reporting period. Since I am studying accounting knowledge in university, I hope I can give your father some advices. I select two important accounting term, accrual basis and faithful representation, which are directly related to preparation of financial statements for your father’s company. I will explain each of them to you in detail.

Accrual basis is one of the most important accounting concepts for preparing financial statements. We should recognize all revenues when earned and all expenses when incurred, regardless of the timing of cash receipts and payments. It is essential because the accrual accounting basis can better evaluate past and future performance of an entity rather than cash accounting basis. Its economic resources and obligations and their changes can be disclosed accurately in the financial statements. For the importance of accrual basis, if it is abode by, the revenues and expenses recognized can reliably reflect all assets and liabilities of your father’s company on a particular date. As a result, the financial statements are very useful to external decision makers such as your father’s biggest borrower Hippo Bank and other suppliers. On the contrary, some consequences may occur in the preparation of financial statement if accrual basis is not followed.

For instance, if your father records rent expenses immediately when cash is paid on the first day of each month, total expenses will be overstated and the profits will be understated in income statement. Because monthly rent expense is not incurred until revenue is earned in that month. Moreover, sale revenues should be recognized once the window washing machines are sold to customers through two channels whether cash is received or not. Sale revenue as well as profit will be understated in that accounting period if your father waits until cash is collected. In addition, your father should...
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