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Cash Basis of Accounting

The cash basis of accounting records transactions only when cash is either received or paid. Transactions that don't involve cash receipts or payments are not recorded under this method. While maintaining books of accounts under the cash basis seems straightforward, it presents several challenges for business owners, government entities, associates, customers, and suppliers. In some cases, business failures can be attributed to the limitations of the cash basis of accounting. Below are some of its drawbacks:

1. Lack of comprehensive information: Inventory held without immediate payment and the right to receive cash from customers after a sale are not recognized as assets or liabilities.
2. Increased risk of loss: Loss of inventory and shoplifting are more prevalent, leading to financial loss for the owner.
3. Distorted asset valuation: Partial cash payments for assets inaccurately reflect the asset's true value.
4. Incomplete profit reporting: The cash basis may obscure the true profitability of transactions.
5. Limited credit evaluation: Bankers may disregard financial statements prepared under the cash basis when assessing creditworthiness.
6. Reduced tax revenue: Tax authorities may not collect the full tax owed by businesses using the cash basis, affecting the nation's revenue.
7. Potential tax evasion: Taxpayers may collude with customers to avoid or delay reporting sales transactions.
8. Compromised reliability: The reliability of accounting information diminishes when the cash basis is employed.
9. Limited application of management principles: Principles of authority and responsibility cannot be effectively applied on a scientific basis.
10. Increased bankruptcy risk: Following the cash basis increases the likelihood of bankruptcy due to its limitations.

These drawbacks highlight the importance of considering alternative accounting methods for more accurate financial reporting and decision-making.