- Select two different types of
HCOs and comment on the most positive and most negative effects of using
the cash versus accrual accounting
method for the business. Include the effect of the choices
on revenue recognition and matching principles.
Expert Solution Preview
Introduction:
For healthcare organizations (HCOs), choosing the appropriate accounting method is essential for efficient financial management. In this question, we will discuss the positive and negative effects of using the cash and accrual accounting method for two different types of HCOs and their impact on revenue recognition and matching principles.
Answer:
Two different types of HCOs are hospitals and nursing homes. The most positive effect of using the cash method for hospitals is that it ensures stable cash flow and helps keep track of the money available for current expenses. The primary negative effect is that it does not provide an accurate representation of their financial status. For nursing homes, the most positive effect of using the cash method is that it permits them to receive payments quickly from their clients. The most negative effect is that it could lead to incorrect assessments of profits and expenses as residents leave and come over the course of a year.
On the other hand, the accrual method is more precise and provides an accurate snapshot of the HCO’s financial health. For hospitals, this method enables proper accounting of liabilities and receivables related to insurance companies, clients, and others. For nursing homes, the accrual method can aid them in determining the general occupancy rate and correctly projecting their expenses.
The revenue recognition principle holds that income should be recorded when earned, whether or not the payment is received. However, the cash method only recognizes revenue when collected, while the accrual method recognizes income when earned. The matching principle states that expenses should be recognized at the same time as related revenue. Accrual accounting better aligns with this principle because it records expenses in the period that corresponding income is earned, providing a more accurate financial picture of the HCO.
Conclusion:
Choosing the appropriate accounting method involves trade-offs between cash flow, accuracy of financial data, and compliance with accounting principles. It is essential to balance these considerations when deciding on an accounting method for HCOs.
