Answer
The cash receipt and disbursement method fail to represent income fairly because:
1. The finalized transaction (not disbursement or receipt of cash) either diminishes or increases income. As a result, a sale on account yields revenue and increases income, while expense incurrence reduces income without regard to time of payment of cash.
2. Consistency also calls for accountable events to receive the same treatment from accounting period to accounting period. However, the cash receipts and disbursement method commonly allow manipulation of timings of expenses and revenues, and this may violate consistency, making the info less applicable.
3. The matching principle also calls for recognizing expenses with their affiliated revenues, and the cash receipts and disbursement method commonly violate this principle.
Work Step by Step
The Generally Accepted Accounting Principles (GAAP) are mainly concerned with the fair representation of business income. On the other hand, taxable income is a statutory concept which stipulates the base for raising tax revenues by the government, and any approach of accounting which is in agreement with the statutory definition will “clearly reflect” taxable income as defined by the Internal Revenue Code.
