Reverted to Cash Flow Rather

¶ … reverted to cash flow rather than accruals accounting, in order to measure financial performance, the need to restore confidence in the financial reporting profession would disappear - and along with it much of the controversy over achieving one set of globally accepted accounting standards."

In the United States, there are two generally permissible methods of keeping track of business income and expenses: the cash flow accounting method and the accrual accounting method. Businesses that have sales of less than $5 million per year are free to choose which accounting method to adopt unless they stock an inventory of items that are sold to the public, in which case they are required to use the accrual accounting method by the IRS ("Cash vs. accrual accounting," INC, 2000). In theory, the cash and accrual methods differ only in the timing of when sales and purchases are credited or debited to the business' accounts. In the cash method, income is recorded when 'cash' (or however the payment is made) is actually received by the business. Expenses are deducted from the business' ledger when the funds are actually paid. But under the more common accrual method, transactions are recorded, and the actual cash addition or deduction may take place in the near or far future.

The accrual method is deemed easier for businesses, as with some transactions, it can be difficult to determine when the actual exchange of funds occurs, particularly if the actual monetary transaction involves a complicated exchange ("Cash vs. accrual accounting," INC, 2000). But for most organizations, the main significance of the mandated or chosen use of one method over another is for tax purposes. Expenses incurred during one tax year cannot be deducted until they are paid using the cash method, but in the accrual method once the transaction occurs, it is recorded as a deduction for that year's tax statement: "You don't have to wait until you see the money or until you actually pay money out of your checking account," to take the deduction in the accrual method, so an organization does not have to wait until it is actually cash-poorer to record a potentially deductible expense ("Cash vs. accrual accounting," INC, 2000).

The advantage of the cash method is that it gives a truer idea of how much actual cash a business has on hand. Furthermore, it lessens the ambiguity as to whether the actual payment will be made to the business -- only when the cash enters or leaves the account can the expense be recorded. What if someone does not pay for the item, for example, even though the actual transaction is recorded, as in the accrual method? This ambiguity is done away with in the cash method, as well lessens the risks of other methods of creative accounting, such as creating fictional future profits or expenses.

The IASB (International Accounting Standards Board) mandates cash flow methods and in fact, studies of the adoption of the IASB standard suggest it increases accounting accuracy. Based on a large sample of firms from different countries after adopting IASB cash flow accounting, firms evidenced "less earnings management, more timely loss recognition and more value relevance of accounting data" than firms without IASB standards (Morais & Curto 2008). The drive towards greater homogenization of international standards has lead the United States FASB (Financial Accounting Standards Board) to consider the IASB's call for a shift to cash flow methods for all organizations. The justification for this is that accruals are more subject to dishonest practices "since every accrual requires certain assumptions and estimates… when a firm completes a sale on credit, it must estimate the likelihood that the cash will be received, when the receipt will take place, and if full payment is uncertain, how much should be reflected on the income statement. None of these issues arise when the sale is for cash" and a firm cannot use assumptions and estimates to inflate profits ("Will global accounting rules help or hinder accuracy," Knowledge @ Emory, 2007).

However, cash flow accounting is not without its critics. Because "accrual account recognizes revenue and expenses in the period they occur, regardless of whether cash changes hands" it may be a better long-term picture of the state of the firm ("Will global accounting rules help or hinder accuracy," Knowledge @ Emory, 2007). Cash flow accounting can more easily be subject to shifts in the flow of receipts and payments, and a firm can choose to 'pack' its cash transactions into a particular period of time when it needs to maximize its impression of profitability. "If managers wish to distort results, they can boost cash inflows by simply delaying the purchase of supplies, or of interest-bearing, short-term securities, and can also delay paying whom they owe" ("Will global accounting rules help or hinder accuracy," Knowledge @ Emory, 2007). .