When preparing their annual financial report for submission to the ACNC, charities will use either cash or accrual accounting. Medium and large charities must use accrual-based accounting in their financial reports Small charities may use either cash or accrual accounting, unless they must use accrual accounting in accordance with their governing document (rules, constitution or trust deed), or by any government department or agency, or funding body. From the 2022 Annual Information Statement, small charities using cash accounting have an additional option to describe their assets and liabilities. The main difference between cash and accrual accounting is the timing of when revenue and expenses are recognised in the books. Cash accounting records revenue when money is received and expenses when money is paid out. Accrual accounting records revenue when it is earned and expenses when they are incurred. Therefore, cash accounting does not record payables and receivables, while accrual accounting does.
 On January 1, a donor enters into a regular giving arrangement for three months with a charity for a monthly donation of $50. The charity's financial reporting period is 1 January to 31 December. Under the cash method, the amount is not recorded until the $50 is received in the charity’s bank account. Under the accrual method, the $50 is recorded in advance of receiving the cash. Assuming that the donation is received on the 21st of each month:
By raising a receivable, a charity is able to keep a track of the money a donor owes or has paid them through the books. Under the cash method, a charity may not be fully aware of their future entitlements at any given point in time.
For the last 12 months, a charity has been paying $100 per month to a website provider to host their website. The provider normally increases the subscription by 2% per annum from 1 December each year. However, if the charity pays the subscription 12 months in advance, the increase will not apply. The charity decides to pay upfront, and pays the $1,200 to the provider on 1 December 2021. The charity's reporting period is 1 January to 31 December.
If you consider the end of year report for this charity, the subscription expense would be recorded as follows:
Cash method: From January 1 to November 30, the charity paid the provider $100 a month in subscriptions (11 x $100 = $1,100). On December 1, the charity paid another $1,200 to the provider. Therefore, the total is $1,100 + $1,200 = $2,300. Accrual method: From January 1 to November 30, the charity paid the provider $100 a month in subscriptions (11 x $100 = $1,100). On December 1, the charity paid another $1,200 to the provider. Under the accrual method only the amount that relates to December is recognised ($100) and the remainder is recorded in a pre-payment account as an asset in the balance sheet ($1,100). Therefore, the total is $1,100 + $100 = $1,200.
The accrual method better captures the subscription expense for the 12-month reporting period, as the accrual system considers the timing of when expenses should be incurred. Definition: When transactions are recorded in the books of accounts as they occur even if the payment for that particular product or service has not been received or made, it is known as accrual based accounting. This method is more appropriate in assessing the health of the organisation in financial terms. Description: To understand accrual accounting, let's first understand what we mean when we say the word 'accrual'. Accrual refers to an entry made in the books of accounts related to the recording of revenue or expense paid without any exchange of cash. The use of accrual accounting is typically useful in businesses where there are a lot of credit transactions or the goods and services are sold on credit, which simply means that there was no exchange of cash. Let's understand Accrual accounting with the help of an example. Suppose you are a firm M/S ABC Pvt Ltd, and you are using accrual accounting to maintain your books of accounts. Here, any revenue or income which is generated by sales and expenses incurred are recorded as they occur. If you sell your goods or products on credit, the sale is recorded in the books based on the invoice generated. There is a possibility that you may not have received the payment by cash at that particular point in time. An expense is occurred or recorded when the raw material is ordered and not when the actual payment is made to the supplier by either cash or cheque. The only drawback of this type of accounting system is that you, as a firm, might end up paying tax on revenues even when you might have not received it (credit).Under the accrual method of accounting expenses are balanced with revenues on the income statement. It helps give a better picture of the company's financial condition. |
What is the name of the method or basis of accounting that records revenues as they are earned and expenses as they are incurred?
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