Question

What is the main difference between cash and accrual accounting? Why is accrual accounting adopted more widely than cash accounting? (160 words maximum)

Explain the concept “depreciation” in your own words. Suppose two companies acquired a same fixed asset at the same time, both of them believe that the useful life of the assets is five years with no residual value. Company A adopts straight-line depreciation method while Company B uses diminishing balance depreciation method at a depreciation rate of 30%. If it is assumed that all the other expenses of two companies are the same, describe the different effects of two methods on firms’ “Depreciation Expenses” and “Profit” in different years. (5 marks – 200 words maximum)

Answer 1

Cash accounting

When financials are prepared on cash basis, they will consider all transactions done through cash whether that transaction related to last year or next year . So this method is not preferred

Accrual accounting

When financials are prepared on accrual basis , they will consider all transactions relayed to this financial year it exclude previous year and next year transactions . It will give exact profit or loss for current year so it is preferable

Depreciation

The company which follows straight line method will depreciate the asset by same amount over it's useful life .So depreciation amt is more than other company and profit must be low . The company which follows WDV method will depreciate the asset on opening balance of the asset. So depreciation amt for this company is less so that profit must be high