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. If this basis 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?
(b) Why would politicians prefer the cash basis over the accrual basis?
(c) Write a letter to your senator explaining why the federal government should adopt the accrual basis of accounting.

a. The difference between accrual-basis accounting and cash-basis accounting is under the accrual basis, companies record transactions in the periods in which the events occur. Using the accrual basis to determine net income means companies recognize revenues when earned rather than when they receive cash. It also means recognizing expenses when incurred rather than when paid. When using the cash-basis, companies record revenue when they receive cash and an expense when they pay cash.

a. Politicians prefer the cash-basis over the accrual-basis because it would mean that billions in unrecorded liabilities would have to be booked, and the federal deficit would increase substantially. The budget deficit's main shortcoming is that it is calculated on the basis of cash flow, rather than economic accrual.
Letter:

Dear Senator,

I am a constituent in your parish and would like to request that you enact a bill that would allow the government to use an accrual-basis instead of a cash-basis program. By using the accrual-basis it would be more beneficial in measuring the U.S. deficit budget. Many constituents and the government will then have a better picture of the “true” debt the country is facing. For example, suppose that an individual kept his books