Accounting methods and systems were designed in response to requirements to provide information to both internal and external users.
In the simplest form, a business needs to determine whether its income is exceeding its expenses. In small enterprises, like a lemonade stand, this is done simply by recording the sales and purchases, and then using simple math to calculate whether the venture produces a profit or a loss.
As a business grows, more detailed accounting and reporting is required to satisfy the demands of the users of information. What began as a simple cash basis accounting now needs to be full accrual accounting. The Internal Revenue Service requires full accrual accounting in most businesses where product inventory is used.
Full accrual accounting, in its essence, matches income and expenses to the period when the income is earned. A cash basis system cannot do this, and the financial results are skewed as a result. Unless all income and expenses fall in the same accounting period, the net results may show a large net income in one period and a large net loss the next.
Employing full accrual accounting produces results as close to the actual results as possible. Consider depreciation, for example, which affects the assets a company purchases, such as machinery. In a cash basis system, the total cost of $3,600 would be charged against incomewhen you buy it. In an accrual basis system, the life of the machinery would ...