Page 117 - Accounting Principles (A Business Perspective)

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Because the cash basis of accounting does not match expenses incurred and revenues earned, it is generally
considered theoretically unacceptable. The cash basis is acceptable in practice only under those circumstances
when it approximates the results that a company could obtain under the accrual basis of accounting. Companies

using the cash basis do not have to prepare any adjusting entries unless they discover they have made a mistake in
preparing an entry during the accounting period. Under certain circumstances, companies may use the cash basis
for income tax purposes.
Throughout the text we use the accrual basis of accounting, which matches expenses incurred and revenues
earned, because most companies use the accrual basis. The accrual basis of accounting recognizes revenues
when sales are made or services are performed, regardless of when cash is received. Expenses are recognized as
incurred, whether or not cash has been paid out. For instance, assume a company performs services for a customer

on account. Although the company has received no cash, the revenue is recorded at the time the company performs
the service. Later, when the company receives the cash, no revenue is recorded because the company has already
recorded the revenue. Under the accrual basis, adjusting entries are needed to bring the accounts up to date for
unrecorded economic activity that has taken place. In Exhibit 14, shown below, we show when revenues and
expenses are recognized under the cash basis and under the accrual basis.
The need for adjusting entries

The income statement of a business reports all revenues earned and all expenses incurred to generate those
revenues during a given period. An income statement that does not report all revenues and expenses is incomplete,
inaccurate, and possibly misleading. Similarly, a balance sheet that does not report all of an entity’s assets,
liabilities, and stockholders’ equity at a specific time may be misleading. Each adjusting entry has a dual purpose:
(1) to make the income statement report the proper revenue or expense and (2) to make the balance sheet report

the proper asset or liability. Thus, every adjusting entry affects at least one income statement account and one
balance sheet account.
January 30
February 9
March 16
April 8
May 18
June 49
July 8
August 14
September 42
October 17
November 13
Subtotal 224
December 376
Total Companies 600
Source' American Institute of Certified Public Accountants Accounting Trends & Techniques (New York' AICPA, 2004) p39
Exhibit 15: Summary-fiscal year ending by month
Since those interested in the activities of a business need timely information, companies must prepare financial
statements periodically. To prepare such statements, the accountant divides an entity’s life into time periods. These
time periods are usually equal in length and are called accounting periods. An accounting period may be one
month, one quarter, or one year. An accounting year, or fiscal year, is an accounting period of one year. A fiscal

year is any 12 consecutive months. The fiscal year may or may not coincide with the calendar year, which ends
on December 31. As we show in Exhibit 15, 63 per cent of the companies surveyed in 2004 had fiscal years that
coincide with the calendar year. In 2008, the comparable figure for publicly-traded companies in the US was 65 per
cent. Companies in certain industries often have a fiscal year that differs from the calendar year. For instance many

Accounting Principles: A Business Perspective 118 A Global Text