Types of Accounting
Episode #10 of the course Introduction to accounting by Martin Ryan
Today, in our final lesson, we’ll talk about variations in accounting.
Accrual vs Cash Accounting
There are two possible times to record a sale as having occurred. The first is when the buyer and seller both agreed to make a deal. The second is when cash is exchanged. Therein lies the difference between accrual and cash accounting.
Cash accounting is interested in when cash actually changes hands. It will not recognize a sale until money has been transferred. Accrual accounting, on the other hand, recognizes the sale when both parties have agreed on a contract for transfer of money, which is usually when the money is earned.
Accrual accounting is the generally accepted accounting principle (GAAP) used by most countries and usually required by the tax department. This is because legally, a sale is complete when both parties have agreed to make a deal.
Cash accounting often makes sense for small businesses because it means the bank account can be used as the main source of accounting records, which simplifies record keeping.
Cash vs accrual accounting does not apply only to sales; it applies equally to purchases, debt, liabilities, or any other transactions.
Choosing the date when an income is earned can be quite tricky. A project may last several months or even years, and payments might be made throughout the project. In this scenario, the usual practice is to recognize the income when the job is completed. If payments are made in installments while the project is being carried out, then the money should debit the bank account and be credited against the liability account, “unearned revenue.” It is only recognized as true revenue when the job is completed.
Management vs Financial Accounting
There are two separate disciplines within the world of accounting. Financial accounting is primarily concerned with presenting financial information through reports, such as the statements we have already seen: the statements of financial performance, financial position, and cash flows. There are a number of standards and procedures to follow in financial accounting, and their work is often used by people outside the organization that they are reporting on.
Financial accountants are great for reporting and for analyzing a company when all that is available is an annual report or set of accounts. They like to interpret and show numbers, but they tend not to have too much influence over the business behind the numbers.
Management accountants are more involved in day-to-day running and analysis of business. They spend the majority of their time looking at their business, where costs are going to, where revenues are coming from, and how to better streamline the business.
If you want to report your business, then talk to someone with specialized financial accounting knowledge. If you want an accountant who will help you run your business better, reduce costs, and improve profitably, then talk to a management accountant. Usually, accountants who specialize in small business do both, and this is fine because the legal requirements for the financial reports are not so stringent for small businesses.
We’ve covered a lot of ground in ten days. We have learned about the six main types of account groups, then saw two of them—revenue and expenses—go into the profit and loss statement. The final profit from that, plus the rest of the account groups—assets, drawings, liabilities, and equity—went into the balance sheet. We’ve gone over debits and credits, which can be summed up as “money goes from one place to another.” The cash flow statement allowed us to track where cash came from and went to. We saw two different ways of accounting for depreciation, then three different ways of structuring a business. Finally today, we saw a few different ways of looking at accounting. I hope you’ve enjoyed the course. Thanks for reading!
If you want to learn more about accounting, consider buying my latest book, I Want to Understand My Accountant, available on Amazon.
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