The GAAP stands for generally accepted accounting principles, and it has its roots in the USA. The GAAP followed by different countries has no uniformity in recording the operations, apart from name uniformity. The financial accounting standards Board issued rules as general principles, standards and procedures. Public companies in the USA follow the rules set by the Board. Indian companies follow Indian GAAP. More than 110 countries around the globe write their accounts with the IFRS system. GAAP differ from country to country. IFRS is the international accounting system. It is easy to compare the financial statements if there is uniformity. Accounting transactions fall under three categories. The three types are cash-based, credit-based and non-cash-based transactions. The standards of GAAP imply the authoritative standards, policy boards and adopted means of writing.
The difference between GAAP and IFRS is the inventory management, inventory reversal, and expenses for research and development. Under the GAAP method, the research expenses are shown as expenses. In the case of the IFRS method, the R&D expenses are capitalised and recorded according to the span of research activity. GAAP has the following principles: regularity with rules, consistency in recording transactions, sincerity, the permanence of methods, transparency with negative and positive numbers, prudence, continuity, materiality, periodicity, and faith. In the case of non-public company, GAAP is not a compulsion but creditors and lenders view the accounting system as a favourable one. GAAP is recorded as an accrual process and not as a cash-based accounting. Accrual accounting is an activity and time-based system. It is not a cash-based system. The difference between the two types of accounting systems is the point of discussion in this blog.
What are the examples of accrual accounting?
The cash-based system gives importance to cash on hand and short-term growth. The accrual-based system gives importance to the long-term growth of the business. Accrual records the non-cash transactions. It affects the balance sheet. It also becomes difficult to understand the revenue and financial position of the company. Accruals reflect the business and growth of the company. This advantage is the reason for the importance of using the accrual system. The following points explain the usage of accrual accounting in the accounting system.
- The accruals are recorded using adjusted journal entries. The adjustment entry made for accrual entry is recorded in the income statement and the balance sheet.
- The asset value goodwill is part of the balance sheet, and it is not measured in terms of cash. This calculation shows that the real and monetary values are measured separately in the accounting system.
- Accounts payable, accounts receivable and interest accrued are the different heads used to record the accrual-based transactions.
- Accrued revenue or receivable is the recognition of revenue. Accrued expenses are the recognition of the expenses in the course of business. Accrued interest is the recognition of an investment or loan.
- The accrual entry is recorded as debit and credit according to the nature of the account. Accounts payable is the credit entry. Accounts receivable is the debit entry.
What are examples of cash-based accounting?
The cash-based accounting system is less accurate and works for short-term calculations. This system suits businesses with less inventory and wants to give more importance to cash on hand. The accounting standard interprets that businesses with cash operations find the cash-based system useful. The businesses that use the credit option and inventory management use accrual-based accounting. The following transactions are examples of cash-based transactions:
- The cash-based system records the sales when the revenue is received. It is irrelevant to record the transaction on the date of sale.
- Cash-based systems record the expenses when the cash payment is made. It is not when it is incurred.
- Cash transactions understate the value of liabilities. It does not consider accrual-based transactions. So, it overstates and understates the business revenue.
- The business calculates tax payments every year. So, if the cash-based system fails to record receipts or payments, it affects the profit, tax calculation and balance sheet values.
The difference between cash and accrual accounting:
- The cash-based system is simple to use and understand.
- Credit based system is a performance-based one. It gives the performance of the company and employees at the right time.
- The cash-based system is straight forward one. It reflects the profits and losses of the business.
- The credit-based system is time-consuming and accurate. It reflects the opportunities and growth in a given period.
- The cash-based system controls the cash flow and enhances tax savings.
- Credit-based systems reflect future growth and liabilities.
- Credit based system controls the funds and manages the finances from different sources.
- Credit-based systems use the depreciation concept. It values the asset and inventory according to the periodical value. It provides tax savings to the business.
Accounting tools record accrual and cash-based transactions:
SAP ERP, QuickBooks desktop pro, NetSuite, Sage Intacct, Gen GST, Gen CompLaw, Gen XBRL, Wolters Kluwer CCH iFirm, CADashboard, Xero, and Microsoft Dynamics 365 Business Central are some of the software names used for recording accounting transactions. The conversion of cash and credit entries made through journal entries. The accounting software’s not configured to understand the difference between cash and credit transactions.
Accrual accounting commercially records the transactions. This system gives a clear picture of performance and growth. The cash-based system reliably records the transactions. It does not show a clear picture of the performance and growth.