UNIT7: ACCOUNTING METHODS
Key unit competence: Operate using either cash or accrualmethods of accounting in QUICKBOOKS
Introductory Activity
MAHORO, a young entrepreneur in MUSANZE district is willing to prepare the
financial reports through QuickBooks and the issue is that he does not know
exactly which accounting method to use and why to use such method.
He always deal with a number of suppliers and customers, paid and unpaid
expense, income paid, unpaid and accrued.
Help him to understand the accounting methods so that he can choose one ofthem to use in his business.
Cash-basis or accrual-basis accounting are the most common methods for
keeping track of revenue and expenses. Yet, depending on your business
model, one approach may be preferable. You will need to determine the bestbookkeeping methods and ensure your business model meets requirements.
7.1. Accrual basis accounting
Learning Activity 7.1.
MUGWANEZA, a sole trader in GATSIBO uses to record the financial
transactions using accrual accounting method. He records every transaction
even the ones which do not flow cash out and in. This affects its final statements
in one way or another. What do you thing is the importance and disadvantagesof this system of recording?
Businesses that use accrual accounting recognize income as soon as they
raise an invoice for a customer. And when a bill comes in, it’s recognized as an
expense even if payment won’t be made for another 30 days.
7.1.1. Benefits of accrual accounting method
The accrual accounting method helps the users in the following ways:
• You have a much more accurate picture of business performance and
finances
• You can make financial decisions with far more confidence
• It can sometimes be easier to pitch for long-term finance
7.1.2. Downsides of accrual accounting
In the other ways, the accrual method should have the disadvantages to
the users:
• It’s more work because you have to watch invoices, not just your bank
account
• You may have to pay tax on income before the customer has actually
paid you
• If the customer reneges on the invoice, you can claim the tax back onyour next return
Application Activity 7.1.
1. Explain the accounting accrual method.
2. List down the advantages and disadvantages of accrual accountingmethod.
7.2. Use accrual methods to Display statements
Learning Activity 7.2.
It is necessary that the accountant prepares the final statements and present
them to the different users. The company should choose the accounting
method to use while presenting such report. Advise to the company manageron the accrual method of accounting.
In quick books software, the reports are prepared and when are to be presented,
the user will select which accounting method to use depending on the business
policy.
Example: TOM AND DON Ltd, RWAMAGANA DISTRICT, PO BOX 1245
RWAMAGANA, and Tel; 0788393737, had the transactions below:
The company started the business with 5,000,000 Frw on bank of Kigali
Purchase of 200 kgs of rice by cheque of 1,000,000 Frw
Credit purchase from creditor Tom 4,000,000Frw
Sales: cash: 1,200,000 Frw, Cheque: 345,000 and credit sales to BUNANI:
2,387,500
Bought land by cash 1,800,000 Frw
Returning goods of 1,000,000 Frw to Tom
Paid 10, 000 Frw of salaries by cheque
Cash drawings Frw120,000
Received rent income by cheque: Frw 31,200,000
Required: Present the income statement and balance sheet using Accrual
method.
For Income statement presentation, Click on Reports, Company & Financials
then Profit & Loss Standard. From these transactions, quick books reports are
presented as here under: (Accrual method).Accrual method, TOM AND DON Trading, profit and loss account.
Figure 7.1 Income statement
The statement of profit and loss account shows the net income of 13,622,500
as revenues and expenses are recognized once they occur.
This income statement is prepared with consideration of paid and unpaid
expenses, received and not yet received income.
Under the same method, the net income is transferred to the balance sheet in
equity section. It may appear as here under:TOM AND DON, Accrual method balance sheet
Figure 7.2 Accrual method balance sheet
Application Activity 7.2.
The following transactions are for BERWA LTD for the month of October
2021.
Oct. 1: Started business with FRW 20,000,000 cash
Oct. 2: Purchase land for the business at FRW 3,000,000 by cash
Oct.4: Purchased office equipment on credit from Equipment Suppliers
Ltd at FRW 2,000,000
Oct. 5: Obtained bank loan of FRW 8,000,000 it was deposited to a
bank A/C
Oct.15: Made part payment of FRW 1,500,000 to Equipment Suppliers
Ltd by cheque.
Oct. 17: Bought motor vehicle from TOYOTA RWANDA at a cost of FRW
15,000,000
Present BERWA LTD Balance sheet and income statement displayed usingaccrual method.
7.3. Cash method
Learning Activity 7.3
In accounting, sometimes business owner decides to use cash method in
recording business financial transactions.Businesses that use cash basis accounting recognize income and expenses• Discuss the reason behind this decision.
only when money changes hands. They don’t count sent invoices (debtors) as
income, or bills not yet paid as expenses until they’ve been settled.
Despite the name, cash basis accounting has nothing to do with the form of
payment you receive. You can be paid electronically (cheques or debit and
credit cards) and still do cash accounting. The cash method is most-commonly
used by sole proprietors and businesses with no inventory.The cash accounting method helps the users in the following ways:7.3.1. Benefits of cash accounting
It’s simple and shows how much money you have on hand
You only have to pay tax on money you’ve received, rather than on invoices
you’ve issued, which can help cash flowIn the other ways, the accrual method should have the disadvantages to the7.3.2. Downsides of cash accounting
users
It’s not accurate: it could show you as profitable just because you haven’t paidyour bills
It doesn’t help when you’re making management decisions, as you only have a
day-to-day view of finances
The accounting repots are always prepared through one of these methods. The
results of the reports prepared from the same transactions but the different
methods are different due to the income and expenses considered once accrual
accounting method is used, which may not appear in the reports prepared using
cash accounting method. Let’s use the same transactions, but cash accounting
method to prepare income statement and balance sheet of TOM AND DON Ltd.
Example: TOM AND DON Ltd, RWAMAGANA DISTRITC, PO BOX 1245
RWAMAGANA, Tel; 078304050, had the transactions below:
The company started the business with 5,000,000 Frw on bank of Kigali
Purchase of 200 kgs of rice by cheque of 1,000,000 Frw
Credit purchase from creditor Tom 4,000,000Frw
Sales: cash: 1,200,000 Frw, Cheque: 345,000 and credit sales to BUNANI:
2,387,500
Bought land by cash 1,800,000 Frw
Returning goods of 1,000,000 Frw to Tom
Paid 10, 000 Frw of salaries by cheque
Cash drawings Frw120,000
Received rent income: Frw 31,200,000
Required: Present the income statement and balance sheet using Cash methodTOM AND DON, Trading, profit and loss account cash method
Figure 7.3 Income statement with Cash method
The statement of profit and loss account shows the net income of 31,200,000
as revenues and expenses are recorded once received or paid.
This income statement is prepared with consideration of paid expenses, and
received income. There is an increase in net income, from FRW 13, 6322,500
to FRW 31,122,500 due to the fact that there is an unpaid cash as long as the
method considers to record cash out once it is transferred to the payee.
Under the same method, the net income is transferred to the balance sheet in
equity section. It may appear as here under:Cash method, TOM AND DON Trading, Balance sheet
Figure 7.4 Balance sheet with cash method
Completing reconciliations is a critical monthly task that ensures that QuickBooks
company records match the banking records. This gives the confidence that
business books are accurate so that the user can trust the reports created forthe business and others.
Application Activity 7.3.
HOPE SHOP started with its operations with 100,000 Frw on bank of Kigali.
During the month, the following transactions took place.
• Purchase of goods by cheque of 70,000 Frw and purchase on credit
of 60,000 FRW from MUNYABARAME
• Credit sales to Peter of 50,000 FRW
• Cash sales of 55,000 FRW
• Sales by cheque of 65,000 FRW
• Returning goods of 25,000 FRW to MUNYABARAME and at the same
date, Peter returned goods of 15,000 FRW to us.
• Paid 1, 000 FRW of salaries by cheque
Required:
Present HOPE SHOP Balance sheet and income statement prepared
using cash method.
Present the general journal, trial balance, income statement andbalance sheet.
End of Unit Assessment
1. Differentiate between cash and accrual method of accounting2. Complete the table below:
3. The following transactions have been extracted from the book of
MANEMATALE Ltd
a) Starting the business with
i. Cash: 12,000,000
ii. Bank: 8,000,000
b) Getting a loan from BK 4,000,000
c) Bought goods on credit from Anna valued at 8,000,000
d) Sales of goods on credit to worth 2,000,000 to Ruth
e) Returning goods of 2,000,000 to Anna
f) Payment of the total amount due to Anna by cheque
g) Ruth returned goods to us valued at 1,000,000
h) Cash payment from Ruth for the total amount due from her.
• Present the income statement and balance sheet using cash
method of accounting
• Present the income statement and balance sheet using accrual
method of accounting