Move from Cash Basis to Accrual Basis
Most of the small use cash basic to record their business transactions as it is simple and straight forward. However, when the business getting bigger, it will not reflect the company’s performance, and it is easily misleading the user.
Cash basic follow the cash movement in the cash book and bank statement. Any cash in will be recorded as the revenue within the period and the cash out will be recorded as an expense. The difference between cash in and cash out will be calculated as profit or loss.
The cash basis sounds very simple and fits with the small business which needs to spend most of the time focusing on operation rather than the accounting treatment. Most of the small companies face a struggle to find talented people to set up accounting policy, prepare accrue revenue and expense, depreciation calculation, and so on. After company growth and the number of transactions increase, management needs more information to analyze and support decision making. A cash basis will not be able to handle, so we need to strengthen the finance department and move to an accrual basis.
Moving from a cash basis to accrual is more complicated than its sound. The company needs to ensure all accountants aware of the change and have enough knowledge to analyze and record the transactions. Next, the company should set a specific date to change, we recommend changing at the year-end which is easy to remember and clear the previous year’s information.
Accounting Policy is the rule or procedure set by the top management as the guide for the preparation of the financial statements. It consists of accounting methods, procedures, and disclosure. Even the company used to have an old policy, they need to reflect it with the accrual basis. It is very important as it provides guardian for staff to follow such as:
- Fixed Asset Useful life
- Depreciation calculation method
- Revenue recognition
- Accounting for inventory and so on.
These are the mains point which is ignored when the company uses cash basis.
Different from cash basis, revenue must be recorded when it occurs even the money is not yet received. The company needs to record revenue and accounts receivable when issuing an invoice to the customers. Accountants need to control all accounts receivable to ensure all cash is collected.
During switching, we need to check if there are any invoice issue to clients but not yet receive payment. It means these invoices are not yet record as revenue under cash basis. So we need to record them (Dr. Accounts receivable & Cr. Revenue) on the first day of changing policy.
When using a cash basis, all fixed assets are recorded as expenses when the company makes payment to the vendors.
Under accrual basis, fixed assets must record when it meet a certain criteria in accounting policy. These assets will be recorded in balance sheet and depreciate over their lifetime. Again, the accountant need to follow the company accounting policy while determining each fixed asset useful life as well as the method of calculating depreciation expense.
During the change, we need to determine the fixed asset listing which still have value on the cut off date. We will start with
Inventory is classified as current asset and it will be recorded as cost of goods sold when they are sold to the customer.
At the beginning of the period, we have to quantify the remaining inventory and adjust them from expense (COGS) to current assets in the balance sheet. Because they were record as expense (COGS) under cash basic.
Advance or Deposit
The amount advance to staff or deposit to supplier is not the expenses. We should record them as asset and reverse to expenses or other assets when they have arrived.
We have to quantify the balance and make adjustment to advance or deposit in balance sheet.
Different from cash basis, the company require to record liability when purchase on credit, and it will be settled when payments are made. Base on a cash basis, expenses are record when the company makes payment.
When moving from cash to accrual, we have to identify the expense or assets which already receive but not yet paid to the supplier. Then we must record them in accounts payable and later on, all the invoices receive should also record too.