Why Financial Statements are prepared on Accrual basis?


Financial Statements assist internal and external users by providing them financial information which they in making economic decisions. As their decisions are based on financial information underlying financial statements therefore, decision making process depends heavily on the relevance and reliability of financial statements which in simple words mean that if financial statements are not reporting the business events properly then it will affect the users, their decisions and their economic condition.

IAS 1 Presentation of Financial Statements requires that entity shall prepare its financial statements using accrual basis of accounting. The reason for emphasizing on accrual basis is that incomes and expenses should be reported in the financial period in which they have been earned and incurred instead of the period in which they are received or paid respectively. We might receive income in a period other then the period in which it has been earned.

If we DO NOT prepare the financial statements on accrual basis then we will NOT able to separate the two distinct events by looking at the financial statements i.e. when the transaction actually occurred and when the cash flow took place.

By following the accrual basis, we recognize the difference of these two important events and thus our financial statements give more accurate information as it contains the information about:

  • How much have been earned or incurred
  • How much is still be received or paid
  • How much has been received and paid (which we can work out easily)

In this way our financial position, financial performance and changes in financial position are better measured.

However, Statement of Cash Flows — which is prepared for cash inflows and outflows is prepared on cash basis. Rest of the items in a complete set of financial statements are prepared on accrual principle which includes the notes to the financial statements as well.


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