Difference between cash basis and accrual basis accounting
The general difference between accrual basis and cash basis accounting is the time of recording the revenues and expenses when accounting. In cash basis accounting, expenses are usually recorded when the actual payment is made regardless of when they were invoiced and the revenues are recorded after the receivership of cash (Russy, SD., 2007). Cash basis generally gives a perfect hint of how cash flows in a business. In the case of accrual basis accounting, earnings or wages are recorded in the particular time in which they are earned in spite of when they are received. It is also viewed as the most accurate form of accounting (William et al., 2009).
. The two forms are used depending on the size of the business. For example, for small business starters, cash method of accounting can be regarded as the best form since the transactions are normally on cash basis (William et al., 2009). For example, a customer buys goods from a store of a proprietor. The seller takes the cash and hands over the equivalent value of goods to the buyer and completes the transaction. The buyer consequently buys goods in cash from manufacturers and waits for a willing buyer who is never guaranteed to appear (the seller puts into record of what he purchased and sells them later when he in fact pays cash).
The above two transactions are put in records at different period of times keeping in mind that the goods involved were bought at a certain date and sold at a later date (Russy, SD., 2007). Cash basis generally gives a perfect hint of how cash flows in a business. A person can buy goods worth $5000 in December intending to sell them that very month but unfortunately sells them in January for $6500. At the end of December, the records will show an expense of the $5000 without revenue to counterbalance the expenditure; thus a loss will be incurred that month. After the sale of the goods worth $6500 in January, the January report will show a profit of $6500. The December report will show a loss of $5000 and that of January will show a profit of $6500, when in real or actual sense the two months revenue is $1500.
In accrual basis of accounting, the records are kept regardless of whether goods and services are bought on credit. Although this system of record keeping has many advantages, it has some setbacks as well. A business can be presented as profitable, while in the real sense, the business has no liquid cash. For example; a company buys goods on credit worth $10000 in December 2000 and records this transaction in its accrual based accounting system. The company pays for the commodities in July 2001. In the company’s accrual form of accounting, an expense of $10000 is recorded in December, even if the actual payment did not take place promptly. The company will have to subtract $10000 from its taxable income of the year 2000 as its business expense. In the case of accrual basis accounting, earnings or wages are recorded in the particular time in which they are earned in spite of when they are received. Accrual method of accountancy is considered the most accurate form of accounting where most or all transactions involved on daily basis are taken into account in spite of the direct flow of cash (Diamond, 2010).
Mergers between companies are supposed to maximise income and output and subsequently reduce costs of a company. The concept of a merger between companies brings about several effects. The labour force is highly reduced because fewer people as compared to before a merger participate in different tasks. Managerial positions require qualified personnel who are not bothered by the change of the running of the business. In this case, we are involved with a merger between a physician group using a cash basis and a healthcare organization using the accrual method. Between the two companies, their modes of accounting differ. First, the two should end their financial crisis and balance their financial books. This will help in avoiding future debts or unnecessary imbalances. Since after the merger the two companies share a common financial approach because they share a similar field, they ought to adopt the same accounting systems to avoid inconveniencies which may result from cash flow differences among other reasons (William et al., 2009).
The best choice that they are supposed to use is the accrual method of accounting. This is because the company will have grown in size, capacity and production because of the merger and the records will increase in volume. In addition, the accrual method usually need many accounts such as deferred revenue, inventory, accounts payable, accounts receivable and prepaid expenses which will require high-quality accounting methods (Diamond, 2010).
When the merger between the two organisations takes effect, one will have to lose its identity whereas the other will still maintain its own. In this case, we will focus on the healthcare as the acquiring company. Because of the type of method of accounting (cash basis) used by physician group, both negative and positive effects will be felt. Since records are kept after receivership of cash according to this method, misinterpretation of the actual expenses and revenue will prevail while computing for the actual assets and liabilities of this organisation. The financial statements will be affected in such a way that the time the transactions-revenue and expenditure, took place is different hence creating complications while preparing group accounts. The type of merger in this case is one involving two different organisations on a similar line of duty-health matters.
References:
Diamond.J, (2010). Performance budgeting– is accrual accounting required? NY: International Monetary Fund. Fiscal Affairs Dept.
Russy, SD. (2007). Accounting & financial reporting: a guide for United Ways and not-for-profit human-service organizations. New York: United Way Institute.
William, ZN. Michael, JM. Noah, DG. Lastzelman, L. (2009). Financial Management of Health Care Organizations: An Introduction to Fundamental Tools, Concepts and Applications. 4(5), 5-96.