Admas University: Individual Assignment Prepare Financial Report

ADMAS UNIVERSITY
Individual Assignment
Prepare financial report
Mamitu Kebede
Id. No.
August 2020
Q1. Difference b/n cash basis and the accrual basis of accounting?
Accrual Accounting Method
Revenue is accounted for when it is earned. Typically, revenue is recorded before any money
changes hands. Unlike the cash method, the accrual method records revenue when a product or
service is delivered to a customer with the expectation that money will be paid in the
future. Expenses of goods and services are recorded despite no cash being paid out yet for those
expenses.
Cash Basis Accounting

Revenue is reported on the income statement only when cash is received. Expenses are only
recorded when cash is paid out. The cash method is mostly used by small businesses and
for personal finances.
The key advantage of the cash method is its simplicity—it only accounts for cash paid or
received. Tracking the cash flow of a company is also easier with the cash method.
But a disadvantage of the cash method is that it might overstate the health of a company that
is cash-rich but has large sums of accounts payables that far exceed the cash on the books and the
company's current revenue stream. An investor might conclude the company is making a profit
when, in reality, the company is losing money.
Meanwhile, the advantage of the accrual method is that it includes accounts receivables and

payables and, as a result, is a more accurate picture of the profitability of a company, particularly
in the long term. The reason for this is that the accrual method records all revenues when they
are earned and all expenses when they are incurred.
For example, a company might have sales in the current quarter that wouldn't be recorded under
the cash method because revenue isn't expected until the following quarter. An investor might
conclude the company is unprofitable when, in reality, the company is doing well.
The disadvantage of the accrual method is that it doesn't track cash flow and, as a result, might
not account for a company with a major cash shortage in the short term, despite
looking profitable in the long term. Another disadvantage of the accrual method is that it can be
more complicated to implement since it's necessary to account for items like unearned
revenue and prepaid expenses.
Q2. Define accrual and deferrals
What is accrual?
Accrual accounting is conducted before the payment of an expense by an organization. The goal
of a company is for the accountant to highlight revenue on the income statement before a
payment is made for the product or service they purchased.
This type of financial information can be perceived as a form of business intelligence because it
takes a deep understanding of a market to know which product you're going to purchase and the
potential for long-term return on investment once revenue is reported on an income statement.
What is deferral?
Deferral accounting refers to entries of payments after they're made. Unlike accrual accounting,
deferral accounting does not count revenue until the following accounting period, so it would be
considered a liability on your financial statement during the period in which you paid for a
product or service.
This is a great way for an organization to show that they have a limited amount of liabilities to be
paid to clients or customers in the present. Therefore, this is a vital aspect for a company to
showcase their financial health to stakeholders and potentially attract new investors.
What's the difference between accrual and deferral?
Responsible accounting procedures provide a framework for management to create financial

development goals to improve the vitality of a business. Accrual and deferral accounting is
largely based on measuring an organization's revenue and expenses. However, there are some
noteworthy differences between these concepts that you should be aware of.
Some of the differences between accrual and deferral accounting include:

 Payment documentation: Accrual accounting alludes to a company expense that's
occurred, but it's not yet reported. For instance, you can incur a cost in January, but the
payment of the expense does not happen until the following month. Deferral pertains to a
payment made in one accounting period, but it's not reported until the next accounting
period. For example, if you made payments at the end of the year but you reported them in
the new year, then that constitutes a deferral.
 Objective: Accrual accounting gives the option of earning revenue you can add to
financial statements, but there is no proof of payment during the accounting period. On the
other hand, a deferral puts a higher priority on showing that you can make payments in the
same accounting period for the expense you incurred.
Q3. Why adjusting entries are needed?
Definition of Adjusting Entries

Adjusting entries are usually made on the last day of an accounting period (year, quarter, month)
so that a company's financial statements comply with the accrual method of accounting. In other
words, the adjusting entries are needed so that a company's:
 Income statement reports the revenues that have been earned during the accounting
period
 Balance sheet reports the receivables that it has a right to receive as of the end of the
accounting period
 Income statement reports the expenses and losses that were incurred during the

accounting period
 Balance sheet reports the liabilities it has incurred as of the end of the accounting period
Examples of Adjusting Entries
Here are a few examples of the need for adjusting entries:
 A company shipped goods on credit, but the company's sales invoice was not processed
as of the end of the accounting period
 A company received some goods from a vendor but the vendor's invoice had not been
processed by the company as of the end of the accounting period
 A company that prepares monthly income statements paid for 6 months of insurance
coverage in the first month of the insurance coverage. (This means that 5/6 of the payment is
a prepaid asset and only 1/6 of the payment should be reported as an expense on each of the
monthly income statements.)
 A company's customer paid in advance for services to be provided over several

accounting periods. Until the services are provided, the unearned amount is reported as
a liability. After the services are provided, an entry is needed to reduce the liability and to
report the revenues.
Q4. What is the Matching Principle?
The Matching Principle states that all expenses must be matched in the same accounting period
as the revenues they helped to earn.
Why Matching is Important to Accountants?

One of the basic accounting principles; it is followed to create a consistency in the income
statements, balance sheets, etc.
Financial statements may be greatly distorted if expenses are recognized earlier rather than later
and vice versa; jeapordizing the quality of the statements and providing an unfair representation
of the financial position of the business.
For example:
 Recognizing an expense earlier than is appropriate lowers net income

 Recognizing an expense later than appropriate raises net income.
Q5. What is the revenue recognition principle?

The revenue recognition principle says that revenue should be recorded when it has been earned,
not received. The revenue recognition concept is part of accrual accounting, meaning that when
you create an invoice for your customer for goods or services, the amount of that invoice is
recorded as revenue at that point, and not when the money is received from the customer.
This is one of the major differences between accrual basis accounting and cash basis accounting,
since with cash accounting, revenue is recognized when payment is received, not when it’s
earned.
Requirements for revenue recognition
The revenue recognition principle requires that you use double-entry accounting. Here are some
additional guidelines that need to be followed in regards to the revenue recognition principle:
1. An arrangement or agreement is in place between your business and your customer. What

this means is that you have offered credit terms to your customer, and they have agreed to
pay the invoice in the amount of time in order to fulfill those terms. For instance, you
provide consulting services to Client A, with credit terms of Net 30. If Client A accepts
those terms, they agree to pay your invoice within 30 days of the date of the invoice.
2. The product or service that you are selling has been delivered or completed. This is one of
the most important components of the revenue recognition principle, which is that
revenue is recognized and recorded when services are rendered or the product delivered.
In essence, this means that your portion of the agreement is complete.
3. The cost has been determined. When you offer your services or sell products to clients,
you must provide them with the cost of those services or products, with the cost finalized
prior to recognizing the revenue.
4. The amount billed is collectible. This is fairly straightforward and speaks to the
importance of accurately vetting clients to determine their creditworthiness. Before you
offer credit terms to clients, you should be reasonably sure that you can collect the
balance due from them at a future date. This is not foolproof of course, because even
properly vetted companies can pay their bills late at times, but this should be the
exception, not the rule.
5. If you have doubts about the collectability of an invoice, it should not be recognized as
revenue. This is a tough one, since it’s unlikely that you will extend credit terms to a
customer that you don’t think will be able to pay their bill. However, if this issue does
arise, you should delay recognizing the revenue until the bill has been paid.
6. If payment is received in advance of products or services, the revenue should be recognized
only after services are rendered. For instance, if your business provides office cleaning
services for $500 a month, and your customer pays you $1,500 for the next three months,
the revenue would be recognized at $500 for the next three accounting cycles, rather than
being recognized in total for the current accounting cycle.

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ADMAS UNIVERSITY

Cash Basis Accounting

Meanwhile, the advantage of the accrual method is that it includes accounts receivables and

Q2. Define accrual and deferrals

What's the difference between accrual and deferral?

Responsible accounting procedures provide a framework for management to create financial

Some of the differences between accrual and deferral accounting include:

Q3. Why adjusting entries are needed?

Definition of Adjusting Entries

 Income statement reports the expenses and losses that were incurred during the

 A company's customer paid in advance for services to be provided over several

Q4. What is the Matching Principle?

Why Matching is Important to Accountants?

 Recognizing an expense earlier than is appropriate lowers net income

Q5. What is the revenue recognition principle?

Requirements for revenue recognition

1. An arrangement or agreement is in place between your business and your customer. What

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