Chapter 3

Exercise E3-2:

On numerous occasions, proposals have surfaced to put the federal government on the accrual basis of accounting. This is no small issue. It these bases were used, it would mean that billions in unrecorded liabilities would have to be booked, and the federal deficit would increase substantially.

Instructions:

(a). What is the difference between accrual-basis accounting and cash-basis accounting?

In accrual-basis accounting, financial transactions are recorded “in the periods in which the event occurs”, as opposed to when money actually changes hands (Weygandt, Kimmel, & Kiesco, 2008, Pg. 95). Cash basis accounting differs from accrual-basis accounting because financial transactions are recorded only when the company actually receives cash, regardless of when the event actually occurred. While a company can use any type of accounting, often individuals and some small companies use cash-basis accounting since “they often have few receivables and payables” (Weygandt, Kimmel, & Kiesco, 2008, Pg. 95). On the other hand, “medium and large companies use accrual-basis accounting” (Weygandt, Kimmel, & Kiesco, 2008, Pg. 95). However, accrual-basis accounting is in line with generally accepted accounting principles, whereas cash-basis accounting is not considered an acceptable practice.

(b). Why would politicians prefer the cash basis over the accrual basis?

Politicians probably prefer cash-basis accounting since transactions are only recognized when actual money is received or paid out. Therefore, the government does not have to report its outstanding upcoming liabilities, such as owed expenses in the form of an accounts payable account. If the government adopted accrual-basis accounting, the politicians would be faced with have to recognize the actual debt of our country, since citizens would be appalled to learn how much outstanding debt truly exists. A retained revenue statement would likely show that the country’s finances are...