business intro

Jon Lapham lapham at extracta.com.br
Mon Aug 4 13:40:40 CDT 2003


Folks,

I've been reading up on the cash vs accrual accounting issues, and it 
seems that this subject should be touched upon in the guide.  However, 
it seems that the issue really only exists in the business world, as 
most personal finance books use the cash method.  This is important for 
GnuCash because our AP/AR system is (if I understand things corectly) an 
accrual way of accounting.

So, wadda ya think about the text presented below (I just wrote it, 
criticism will be very welcome)?

Oh, also, where should this text go?  A new "intro to business" chapter? 
  I don't think we want to have this anywhere near the personal finance 
people, so it should definitely stay in the later chapters... but where?

=====================================

There are two main methods of accounting, cash accounting and accrual 
accounting.

In the cash accounting method, you enter income into the books when you 
actually receive payment, and you record expenses when you actually 
write a check.  Most personal finance is recorded using the cash method 
because it is simple to impliment, and fairly accurately represents most 
personal finance transactions.  However, for business accounting this 
method suffers from some serious drawbacks.  Most notably, it is 
difficult to determine your real financial standing when you buy or sell 
items on credit, a very common business activity.

In the accrual accounting method, you enter income in the books when you
make a sale, regardless of whether you have received payment or not. 
Inline with this, you record expenses when you receive goods or 
services, even if you will only pay for them at a later date.

The advantage of accrual accounting in a business setting is that it 
gives a more accurate picture of your finances within a financial 
period, even if payments will be arriving or leaving outside of this 
period of time.  The biggest disadvantage to the accrual method of 
accounting is that it is more complex, requiring entry of a sale or 
purchase twice.  Once at the time of the sale or purchase, and again at 
the time it is paid for.

The following is an example of a common problem with using the cash 
method of accounting in business. It is possible to artifically inflate 
apparent income in a period simply because many customers paid their 
bills from previous periods, but not due to increased sales.  This kind 
of accounting distorts the financial view of the company, which may lead 
to making incorrect business decisions.

-- 
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  Jon Lapham  <lapham at extracta.com.br>          Rio de Janeiro, Brasil
  Work: Extracta Moléculas Naturais SA     http://www.extracta.com.br/
  Web: http://www.jandr.org/
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