Measurement of income under accrual accounting | Financial Statement Analysis
In a discussion of corporate income, a user of financial statements alleges that “One of the real problems with income is that you never really know what it is. The only way you can find out is to liquidate a company and reduce everything to cash. Then you can subtract what went into the company from what came out and the result is income. Until then, income is only a product of accounting rituals.”
1. Do you agree with the above statement? Explain. What problems do you foresee in measuring income in the manner described?
2. What assumptions underlie periodic measurement of income under accrual accounting? Which income approach do you think is more reasonable? Explain.
Personally, I do not agree with the statement that has been mentioned by one of the financial users who mention that with the use of cash basis of accounting only we can have a proper understanding to extracting the real income of people which cannot be obtained with the accrual basis of accounting. The user believes that we cannot get the precise, actual, and relevant figure of income data with the accrual basis of accounting.
We know that the accrual basis of accounting records all the receivables that are not received yet but the company expects to receive in the future and also there is a chance that the receivables can be bad debt (Accrual Basis, 2019). This might be also the reason why the user believes in the cash basis of accounting rather than the accrual basis of accounting. As per the understanding of the user, real income can only be achieved by liquidating the business & subtracting the received cash flow after the liquidation along with the company’s investment in cash.
As compared to the cash basis of accounting, the accrual basis of accounting makes the required necessary adjustments under its income regarding the consequences that can occur in the future of the present business activities in terms of the cash flows. Whether cash or credit, the income can be earned in any form on a certain period.
Today in this world of growing competition business organizations have their multiple networks of suppliers, customers, creditors, etc. And it not possible for the business to have a transaction of business activities in the form of cash. The company does generate profit but in terms of credit that will be converted into cash and the accrual basis of accounting records the activities of the company regardless of the cash transaction as it follows the principle that within the same period of occurrence of the event, income and expenses must be recorded.
Stanley, J. (2019, August 1). Accrual Basis. Retrieved from Accounting Tools: https://www.accountingtools.com/articles/2017/5/7/accrual-basis