How Accounting Methods Affect Financial Statement Analysis

Accounting methods used by an entity determine how the transactions are recorded in the books of accounts of that company. Jan says the most common methods of accounting are the cash and accrual basis of accounting. One basis of the difference is the recording of cash in and out in an entity. In cash-basis accounting, companies’ expenses are recorded when the actual use of the cash has been done.

The revenue is only recognized when the cash is in the hands of the entity. An excellent example is where a worker completes some work in 2012 but does not get paid until 2013, when the work is inspected by the owner. The earnings paid to the worker in 2013 will only recognize in 2013 customers. This system is easier for small organizations because it is an easier method of keeping accounting records.

Another method used is accrual accounting. Under this method, the revenues are recorded only after the completion of the transactions. This means that when the actual work is completed. For instance, in the above example, the worker will have recognized the revenue immediately after completing the project, that is, in the year 2012, and not when he received the cash. In short, companies using this method records revenue when it is earned even if they have not been paid. The recording of the expenses is done in the same manner.

This means that the recording of the expenses will only occur when they are incurred. This will happen no matter whether the supplies have not been done. According to the generally accepted accounting principles, all incorporated companies must use this method to ensure a good presentation of the financial statements. Financial statements analysis involves the comparison of the financial statements. There are two main methods of financial analysis; horizontal analysis is the one that compares the financial components between two or more accounting periods.

For instance, account receivables can be compared between two different periods of time. Vertical analysis, on the other hand, compares the different components of the financial statements over the same period of time and reports this in terms of percentage. The method can compare numerous items to one definite item in the same accounting period.

This method has also been used to compare periods to others. It is thus helpful in developing trends. This can reveal trends used in decision-making. In both the vertical and horizontal statement analysis, the accrual method is more meaningful than the cash basis. This is because accrual accounting allows revenues to be matched with the expenses used to earn them or those earned in the same accounting period. This makes it meaningful and easy to comprehend for analysts and the company.