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

Expert Answers
pacorz eNotes educator| Certified Educator

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.

skb123 | Student

Accrual basis of accounting is generally preferred over cash accounting as its gives a true and fair picture of the fianancial statements.

Accrued as the name suggest means an income or expense has earned /recognized even though the related receivable / payable has a future date.

for example that the salary of a staff is due on the last of the month but is paid on the 1st of next month .(Accounting year is assumed from Jan 1 to Dec 31st). now for the last month December the salary is due on 31st itself so if accrual accounting is followed the expense will be booked in the same year

Salary DR.

  Salary payable

But if cash accounting is followed it will be booked next year only when it is actually paid.