According to FASB, accrual accounting is superior to cash accounting. This is because accrual accounting utilizes the caution and equivalent concepts. For instance, accrual-based accounting shows the responsibilities and available resources of the organization. Thus, accrual-basis accounting has a more precise description of the financial status. When utilizing cash-based accounting, revenues are reported when the cash is received from customers and expenses are reported when cash is paid. This may not accurately represent the current standing of the organization. Thus, the matching principle shows the necessity of accrual accounting because it shows the transactions in the period of which they occur.
The accounting pronouncement that specifically observes, that “this Statement relies on a basic premise of generally accepted accounting principles that accrual accounting provides more relevant and useful information than does cash basis accounting” is Statement 106. The purpose of this statement was to “establish accounting standards for employers’ accounting for postretirement benefits other than pensions (hereinafter referred to as postretirement benefits). Although it applies to all forms of postretirement benefits, this Statement focuses principally on postretirement health care benefits. It will significantly change the prevalent current practice of accounting for postretirement benefits on a pay-as-you-go (cash) basis by requiring accrual, during the years that the employee renders the necessary service, of the expected cost of providing those benefits to an employee and the employee’s beneficiaries and covered dependents” (IASB, 2014). Thus, this standard is designed to challenge employee accounting for postretirement benefits other than pensions.
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"Cash Basis or Accrual Basis".
Cash-basis methods are not typically utilized. In fact, the only organizations that utilize cash-basis methods are small businesses and some not-for-profit. Many of these organizations are classified as not having any inventory. However, significantly, expenses and revenue for previous periods for those organizations that utilize cash-based accounting cannot be measured. This is because this method is not congruent with the matching principle.
Cash-basis accounting could be utilized complementary to accrual accounting, particularly for small businesses. It would be suggested to utilize cash-basis accounting for internal use, yet accrual accounting to satisfy GAAP requirements. The reason this is beneficial is because it shows the cash in/cash out function for simple organizations. For instance, if the organization has no inventory or assets, it may be easier for interested parties to see where cash flow comes in and goes out, rather than accrual-based accounting. Thus, these organizations may be too simple to have the need for accrual-based accounting.
The ease of audit is dependent upon the reason for the audit. For instance, if the auditor is simply determining whether or not transactions are recorded accurately, then cash-based accounting is simpler to audit. However, if the auditor has the goal of determining how individual transactions affect the health of the organization, then accrual-based accounting is easier to audit. It is suggested that there is guidance that sponsors the idea that certain earnings may be accounted for on an accrual basis while the related income taxes are accounted for on a cash basis.
Most not-for-profit organizations have changed from a cash or “modified cash” basis to accrual accounting. This was completed in 1994. It was done in order to improve understandability relating to the financial statements from these organizations. Furthermore, the change allows for information to be provided regarding the organization as a whole, rather than individual components. As a result, it meets the needs of interested parties, such as stakeholders and other investors, such as lending institutions. By changing to accrual-based accounting, it was possible to compare accounting periods.
