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Most Popular Accounting Methods in the US

Written By: Samuel

Accounting is the language of business; the success or failure of a business is recorded and reported using accounting. Accounting, generally speaking, involves the steps taken in making entries of financial transactions (economic exchanges between parties or businesses) for the preparation of financial reports. The practice of accounting ensures full and fair disclosure of the financial position and condition of business entities in compliance with principles, methods, rules, and regulations. There are two universal methods of accounting that determine how an entity records its business transactions: cash-based accounting and the accrual method of accounting.

Cash-based method of accounting

Cash-based accounting is a method of recognizing transactions as cash changes hands. Using this method, business entities record expenses when cash is actually paid out and record revenues when the cash is received. Expenses are not recognized until the money is actually paid, and previous revenues earned are not recognized until payment is received.

Say a company sold an item in December 2013 but received payment in March 2014, the transaction would be recorded in March despite the actual transaction having taken place in December of the previous year. Sole proprietors and partnerships use this accounting method because it is easier and more straightforward. The main drawback of using this method is that revenues and expenses are not properly matched to their actual period, hence, month-to-month records tend to be distorted.

Accrual method of accounting

The accrual method is a good method for matching revenues and expenses to the period to which they relate. Business entities record expenses when they are completed and not necessarily when the money is paid out or received.

Say a company sold an item in December 2013 but received payment in Match 2014. The transaction would be recorded in December 2013 despite payment not having been received then. In the United States, all companies that incorporated as limited companies, as directed by the Generally Accepted Accounting Principles (GAAPs), must use the accrual method of accounting. The accrual based accounting method is guided by two boards:

• General Accepted Accounting Principles (GAAPs), as promulgated by the US Financial Accounting Standard Board (FASB) 
• International Financial Reporting Standards, as promulgated by the International Financial Accounting Board (IASB)

The IFRS is grounded in the same principles as the GAAPs, and the two, more often than not, lead to the same results, though there are some differences. GAAP is the recognized set of standards used for financial reporting and is recognized as such by the Financial Accounting Standard Board (FASB), Government Accounting Standards Board (GASB), and American Institute of Certified Public Accountants (AICPA)

Under the accrual method, various reports are expected:
1. Statement of financial position
2. Statement of profit or loss
3. Statement of comprehensive income (single, continuous, or two consecutive statements)
4. Statement of cash flow
5. Accompanying notes to the financial statements

Business entities in the United Stated with gross revenues less than USD 5 million per annum may generally choose to use the cash-based method, while those with gross revenues exceeding this figure generally choose the accrual method of accounting. Secondly, private business that are not required to publicly disclose their financial results are free to use either method. For business entities that are incorporated as limited, they must comply with regulations and use only the accrual method of accounting. The key difference in the two methods is how the entity records cash coming in and cash going out.