Users require a variety of information about the financial position and performance of a firm in order to make decisions. Users cannot wait until the life of the business is completed. Accordingly, the accounting period assumption requires that

Question

financial reports depicting changes in wealth of an enterprise be prepared periodically. Required: Explain the relationship between the accounting period assumption and accrual basis accounting.

Answer 1

The accounting period assumption states that an enterprise should provide periodic, short-term financial reports, thus requiring the use of accruals and deferrals in order to identify revenues, expenses, gains, and losses with specific time periods. The use of accruals and deferrals represents the primary difference between the accrual basis of accounting and the cash basis of accounting. Under the accrual basis of accounting, revenues are recognized when earned (not when cash is received) and expenses are recognized when incurred (not when cash is disbursed). Each period, accruals and deferrals are used for items such as prepaid expenses, uncollected revenues, unpaid wages, and depreciation expense. The use of accruals requires that judgments and estimates be made, rendering financial reports more arbitrary and imprecise. These drawbacks are offset by the significance of periodic financial report to users in making decisions.