“Compare the Relative Advantages and Limitations of Financial Statements Prepared on a Cash Basis with Those Prepared on an Accrual Basis”

Topics: Generally Accepted Accounting Principles, Income statement, Business Pages: 3 (1018 words) Published: March 30, 2011
“Compare the relative advantages and limitations of financial statements prepared on a cash basis with those prepared on an accrual basis”

To compare the advantages and limitations of different financial statements begins with first understanding what financial statements are and what different purposes they can be used for, as well as the differentiation between cash and accrual accounting. The cash and accrual methods of accounting are the two principle ways of keeping track of businesses takings and expenses and in the majority of cases it is possible to decide which method is best for a business on an individual basis, although in all cases cash based accounting can only apply to small businesses earning less than £1.35 million, so large businesses will always have to rely on the accrual based method to prepare their financial statements.

Financial statements are written reports that describe the financial status of a company; it is one of the main functions of financial accounting. It consists of a profit and loss account and a balance sheet. Within the financial statement there are a few limitations that apply to both accrual and cash based accounting, the first thing is that the financial statement is ‘largely historical’, meaning that it can tell you what an entity has done positive or negative in the previous overview but it cannot necessarily ‘reflect future events or transactions’. The financial statement also mainly focuses on the financial effects of the company and not, essentially, the non-financial effects or information in general. But as an advantage the financial statement can be used as the main source of a company’s activities for those who do not have full ability to access a company’s economic activity.

Cash-based prepared financial statements are those that are recognised when a fee has been received or paid. A cash basis would mean that a payment is shown even if a service has not yet been provided or good has not yet been...
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