How to Convert Cash to Accrual

Convert from cash-based to accrual-based accounting to produce GAAP-based financial statements. GAAP (Generally Accepted Accounting Principles) requires accrual-based accounting because it more accurately reflects a company's financial position. On the cash basis, only cash received and paid out is recorded. This method ignores any income the company has earned but has not yet received and any expenses the company owes but has not yet paid. It also ignores any contingencies that might affect the company's financial condition in the future. Here are the considerations in converting from cash- to accrual-based accounting.

Difficulty: Moderate

Instructions

1. Get to know the meaning of the terms. If the company closed down today, what amounts would it still be entitled to collect from others and what amounts would it still be required to pay to others? These amounts are called receivables, accruals and deferrals.

2. Account for receivables and prepaid expenses. Receivables include trade accounts receivable, such as sales completed but not yet paid for, and employee advances not yet repaid to the company. They also include loans made by the company to others (but not yet repaid). Prepaid expenses include payment for services, equipment, inventory or other items paid for in advance (but not yet received). Converting to the accrual basis requires a debit to the appropriate asset account, and a credit to the appropriate income or expense account.

3. Set up liability accounts by determining what the company owes to others but has not yet paid. This includes loans the company has not yet repaid and expenses the company owes but has not yet paid. For example, if employees have worked during one period but won't be paid for that work until the next period, the company has an accrued expense for salaries or wages payable. If the company has received goods or services but has not yet paid for them, the company has an accrued expense for these amounts. Converting to the accrual basis requires a credit to the appropriate liability account and a debit the appropriate expense account.

4. Consider contingencies that may result in the company receiving or owing money in the future. For example, if the company is involved in a lawsuit, the managers must estimate the costs of defending or prosecuting the lawsuit and the expected result (either how much the company will win or lose when the case is settled). The managers must devise a formula to estimate these amounts if there is a better than 50 percent chance that the outcome is known. These contingencies are accounted for in a separate section of the company's accrual-based balance sheet.

5. Disclose any other information that might affect the company's financial condition in the notes to the financial statements. GAAP requires these disclosures as a part of accrual-based accounting. These disclosures are designed to insure transparency so lenders, investors and others who will have access to the financial statements can make informed decisions about the company's financial condition.