Financial data can be recorded on the cash or accrual basis. Once either basis has been decided upon, financial data must be maintained and reported using that basis.
Cash basis accounting states that income and expenses are recorded when a payment is received or an expense is paid. You record income when you deposit the check from the customer. You record expenses when you write the check to the vendor. A business may utilitize accounts receivable and payable to track amounts due and owed, but the financial statements must be adjusted to cash basis for reporting purposes.
Accrual basis accounting states that income and expenses are recorded when services are rendered or goods received. Cash payment may not have been received or paid out yet. Accrual basis accounting uses Accounts receivable, Accounts payable, and Prepaid expense accounts.
Accrual basis statements provide a more accurate picture of the financial condition of a business on a monthly basis, particularly if that business extends credit to customers, purchases on account, or purchases supplies or other products in advance of need. Consider a business experiencing cash flow problems in a given month. They extend payment on some of their bills. Those accounts payable would not appear on a cash basis financial statement, giving the appearance of a better than existing financial condition.
A business with a number of accounts receivable must keep track of customer accounts. This can be done in an accounts receivable ledger. Each customer would have their own page in the ledger. Transactions would be recorded as follows:
The same applies to accounts payable. The individual vendor account is credited for the amount of the transaction and the appropriate expense account is debited. When payment is made on an account payable, the vendor account is debited and the cash account is credited.
Some expenses like insurance which cover a period of time in the future may be recorded as prepaid and expensed over the period of time. For example, a business pays an insurance bill on the first day of the new year in the amount of $3,000 to cover the first quarter of the new year. It debits "Prepaid insurance" and credits "Cash." At the end of the first month, one month of insurance coverage has been used, so "Prepaid insurance" is credited in the amount of $1,000 and "Insurance expense" is debited. The business does the same thing at the end of the next two months. Using this method, the business will show $1,000 in insurance expense each month instead of a large $3,000 expense in one month and no expense in the following two months.
In a large business where the owner is not able to directly supervise all accounting activities, controls must be implemented to insure honesty and accountability.
Keep petty cash vouchers in the box. As cash is removed from the box, a voucher is filled out with the amount. The voucher is left in the box. When cash gets low and the petty cash needs to be replenished, the vouchers are removed and the petty cash reconciled. The total of vouchers plus remaining cash should equal the amount originally put in the box.
A check is written in the amount of the vouchers ($9.75 in our example to the right), cashed, and the money put in the petty cash box to begin the cycle again.
That transaction is recorded as a debit to the appropriate account for each expense and a credit to "Cash" of $9.75. In this way, the "Petty Cash" account on the financial statements remains untouched after initial creation unless there is a need to increase or decrease the amount.