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Why is the accrual basis of accounting generally preferred over cash basis, and give an...

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soman2006 | Student, Undergraduate | Salutatorian

Posted July 13, 2011 at 8:16 AM via web

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Why is the accrual basis of accounting generally preferred over cash basis, and give an example of why accrual is preferred over cash

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pacorz | High School Teacher | (Level 3) Educator

Posted July 13, 2011 at 11:32 AM (Answer #1)

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Accrual accounting is generally preferred because it gives a fairer picture of the business' real obligations, including those transactions that have been committed to but not yet completed. In accrual accounting both credits and debits are booked as soon as they are created; for example, when you bill a customer, that amount is credited to accounts receivable and is treated as earned, although not yet received. Similarly, money committed to a purchase is considered spent when committed.

Here's an example. XYZ company builds and sells widgets. This month XYZ placed an order for $8000 worth of materials, and received a payment of $12,000 for its last batch of widgets sold. Without accrual accounting, it looks like XYZ is $12,000 to the good, but the reality is that $8,000 of that money is headed right back out the door for materials. By booking the $8,000 order as "spent", we see that XYZ has actually made $4,000, which is the true case.

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