which of the following statements describes why accrual accounting better reflects a business’s performance?
Which of the following statements describes why accrual accounting better reflects a business’s performance?
Answer:
Accrual accounting provides a more accurate picture of a business’s performance compared to cash accounting for several reasons. Here’s a detailed explanation:
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Matching Principle:
- Accrual accounting aligns revenues with the expenses incurred to generate them, giving a more accurate representation of profitability. This is achieved through the matching principle, which records expenses in the same period as the associated revenues.
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Revenue Recognition:
- Revenues are recorded when earned, regardless of when cash is received. This allows businesses to recognize income at the point of sale or service, whether or not payment has been collected.
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Comprehensive Financial Picture:
- It provides a complete view of financial obligations and income, recording accounts payable and receivable. This approach acknowledges all debts and receivables, providing a clear view of future cash flows and financial health.
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Timeliness and Relevance:
- Accrual accounting ensures that the financial statements reflect transactions in the periods they occur, offering timely and relevant information for decision-making. This allows managers and stakeholders to understand the ongoing business activities better.
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Long-term Analysis:
- It facilitates better performance analysis over time by reducing the fluctuations caused by cash timing differences, offering a steadier view of operational results.
In essence, accrual accounting reflects the true economic activities of a business, beyond just cash transactions, offering critical insights into financial performance and obligations.