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Pros And Cons Of Accrual Accounting

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Accrual accounting is an accounting method that recognizes economic events regardless of when cash transactions occur in order to measure the performance and position of a company. The general idea is that economic events are matching revenues to expenses to recognize which is the matching principle at the time in which the transaction occurs rather than when payment is made (or received). This method allows combining the current cash inflows or outflows with future expected cash inflows or outflows to give a more accurate picture of a company 's current financial condition. Accrual accounting is considered to be the standard accounting practice for most companies with the exception of very small operations. This method provides a more…show more content…
Accrued revenue is income which has been earned but not yet received and the accrued revenue term is sometimes also applied to revenue for which an entity has not yet issued a billing, and for which it has not yet been paid. This is a common occurrence in the services industry, where a project may issue an invoice at the end of the project to involve billable services for several months. Accrued revenue is usually listed in the current assets section of the balance sheet in an accrued receivables account. Ohlson (1995) and Feltham and Ohlson (1995), show that future profitability and firm value depend on growth in net operating assets as well as current profitability. They can disaggregate growth in net operating assets into two components which are accruals and growth in long-term net operating assets—just as they can disaggregate profitability into accruals and cash flows from operations. Prior research on the persistence and valuation of cash flows vs accruals focuses on the role of accruals as a component of profitability, but overlooks the role of accruals as a component of growth in net operating assets. Their study probes the extent to which the differential persistence and valuation of accruals documented in prior research can be explained by the role of accruals as a component of growth in net operating assets. In other words, they investigate whether the differential persistence and apparent mispricing of accruals that Sloan (1996) documents apply more…show more content…
Prepaid revenue is prepayments that a business receives from its customers for delivery of goods or services in the future. Businesses cannot record customer prepayments as recognized revenues until sales to customers are completed based on the revenue recognition principle. Thus, prepaid revenues are liabilities for businesses, and become earned revenues over time as they complete the intended sales. Revenue is recognized under the accrual method at the time the sale is made or the services are rendered because it is at this point that the revenue, if any, can be objectively measured. A third party which is customer has agreed to be bound for a determinable quantity of goods or services at a specified price, and the enterprise has performed the services or delivered the goods, resulting in the "passing of title." In other words, the acceptance of a purchase order before the goods are delivered, or the signing of a contract for the future performance of personal services, does not result in the recognition of revenue under the accrual method. In the Cox case, the taxpayer rendered investment management services for its clients for which it received advance quarterly fees. The income from these was deferred until the services were performed. The taxpayers’ clients would turn over cash or securities to a bank, which then would buy and sell securities as the management firm directed. There were three facts in this case that distinguished it from Schhide and that
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