Cash Vs. Accrual Accounting in Canada
The two primary types of accounting used in Canada, as well as the rest of the world, are cash and accrual based accounting. Cash accounting is not used as often as accrual accounting due to the inaccuracies and errors it presents, and because accrual based accounting provides a clearer image of a company's finances.
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Assets
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In accrual based accounting, assets (revenue) are added to the financial statements when the action that they are related to occurs. This principle is known as revenue recognition. As an example, if $600 of merchandise or services is sold to someone, and he owes you additional monies, you record "$600" even if you have not received what is due yet. Because of this, your financial statements reflect the fact that your business has done an additional $600 of business despite the fact that you have not received a hard cash value for it. With cash accounting, the assets received in transactions are recognized only when the money actually changes hands, making it harder to keep track of the health of a business as well as when transactions take place.
Liability
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In accrual based accounting, the amount of various payable categories (such as salary and accounts) that have not yet been paid can be recorded at the end of every reporting period, thus accurately representing the state of the business's finances. When payment occurs, money is removed from the payable to the equity column as an expense. In cash accounting, payables are only recorded when there is an actual change of liquid cash. Because of this, the business's finances do not reflect the money owed to other parties and as such do not accurately reflect its financial situation.
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Equity
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Equity in accrual accounting is the basis of the system, differentiating it from cash based accounting. The two primary laws that govern accrual accounting are revenue recognition and the matching principle. The matching principle interacts with revenue recognition by recording all expenses at the time that the revenue they generated is also recorded. For example, if a company sells $2,000 of merchandise, which cost $400 to purchase wholesale, then $2,000 of revenue will be recorded at the same time that $400 of expense is recorded on the financial statements, reflecting the fact that that expense happened to generate that revenue.
Usage
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Accrual accounting is used by all formal entities in major financial countries (all first world and most third world) due to its increased accuracy over cash based accounting. The primary uses of cash based accounting are in sole proprietorships (i.e., where no one else owns a portion of the business) and personal finances, though it isn't always wise due to the fact that it is harder to keep track of what is owed (to you or to others) if it has not yet been paid.
Legality
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Another reason for the unpopularity of cash based accounting in Canada is that it is illegal, per national and international laws, to use it in any formal organization. This is because cash based accounting misrepresents the health of a company and makes it easier to hide illegal activity as expenses do not have to be recorded with the revenue they incurred and can therefore be manipulated.
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References
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