CASH ACCOUNTING

When we first began accounting, we were doing cash accounting. If you review some of the

exercises you will notice

• - Whenever an expense occurred, there was a decrease in cash.

• - Whenever revenue came in, there was an increase in cash.

Consequently, revenue, expenses and the cash flows related to them are recognized in the same ________ period they occurred. Revenue, expenses and the related cash flows all show up on the end of the period financial statements for that period. Now, lets look at some questions that highlight the limitations of cash accounting. Example 1: We may have done work for a client (earned revenue) and then received partial payment two weeks later, finally receiving the rest before the end of the accounting period. Our balance sheet at the end of the period sees these events as happening at the same time. QUESTION 1: What if we did the work (earned revenue) this period, and then the period ends before we get paid? Example 2: We may have had a plumber over to fix a leaky pipe (incurred an expense), and then paid them three days later before the end of the accounting period. At the end of the period our balance sheet recognizes the work done and cash payment as having occurred at the same time.

QUESTION 2: what if we had the plumber over (incurred an expense), but were unable to pay them before the end of the period? These questions highlight problems for cash accounting. How do we link revenue/expenses on a balance sheet to cash flows that occur during a different period? To correct this, we introduce accrual accounting.