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Factors that influence small and medium enterprises in Metro Manila to choose between accrual and cash accounting.

INTRODUCTION

In this age of globalization globalization

Process by which the experience of everyday life, marked by the diffusion of commodities and ideas, is becoming standardized around the world. Factors that have contributed to globalization include increasingly sophisticated communications and transportation
, the harmonization har·mo·nize  
v. har·mo·nized, har·mo·niz·ing, har·mo·niz·es

v.tr.
1. To bring or come into agreement or harmony. See Synonyms at agree.

2. Music To provide harmony for (a melody).
 of financial reporting requirements has become a necessity. The convergence of accounting standards worldwide helps ensure the increased level of confidence among investors and other users of financial information by high quality and globally adopted financial reporting structures.

Based on the fundamental assumptions of accounting, principles are developed. These dictate how economic events are recorded and reported. Generally accepted accounting principles The standard accounting rules, regulations, and procedures used by companies in maintaining their financial records.

Generally accepted accounting principles (GAAP) provide companies and accountants with a consistent set of guidelines that cover both broad accounting
 (GAAP GAAP

See: Generally Accepted Accounting Principles


GAAP

See generally accepted accounting principles (GAAP).
) are designed to produce general-purpose financial statements of business enterprises, whether they are large or small. The users of general-purpose financial statements include shareholders, creditors, investors, employees, and public.

Users of financial reports focus on earnings as well as on the financial condition of the enterprise. To measure an organization's performance and reflect its financial condition, two accounting methods are commonly used: accrual accounting Accrual Accounting

An accounting method that measures the performance and position of a company by recognizing economic events regardless of when cash transactions happen.

Notes:
 and cash accounting.

GAAP require the use of the accrual method of accounting. The accrual method recognizes revenues and expenses in the accounting period in which they are considered earned and incurred regardless of the inflow or outflow of cash. On the other hand, the cash accounting method recognizes revenue when cash is received and recognizes expenses when they are paid. However, there is a question of whether GAAP is applicable to small and medium enterprises (SMEs), and whether GAAP meet the needs of these companies, as well as the preparers and the users of their financial reports.

Based on literature, there are two major criteria applied in classifying SMEs: asset size and number of employees (PSB PSB Pet Shop Boys (band)
PSB Public Service Broadcasting (radio and television)
PSB Public Service Board (Vermont)
PSB Public Security Bureau (China) 
 ASEAN ASEAN: see Association of Southeast Asian Nations.
ASEAN
 in full Association of Southeast Asian Nations

International organization established by the governments of Indonesia, Malaysia, the Philippines, Singapore, and Thailand in
, 2005). In the Philippines, the Philippines, The (fĭl`əpēnz'), officially Republic of the Philippines, republic (2005 est. pop. 87,857,000), 115,830 sq mi (300,000 sq km), SW Pacific, in the Malay Archipelago off the SE Asia mainland.  SMEs sector are those companies engaged in different areas of business whether cooperative, partnership or corporation that can be categorized by asset size or by employment. Republic Act 9178 provides that the small enterprise ranges from 10 to 99 workers and capitalization of Php3,000,0001 to Php15,000,000; and the medium enterprise has workforce of 100 to 199 and capitalization over Php15,000,000 to Php100,000,000.

This paper presents the important considerations of SMEs in Metro Manila For the capital city of the Philippines, see .
Metropolitan Manila (Filipino: Kalakhang Maynila) or the National Capital Region (NCR) (Filipino: Pambansang Punong Rehiyon
 in using an accounting method. Geographically, Metro Manila is the center of Luzon and the capital region of the Philippines. The Cordillera cor·dil·le·ra  
n.
An extensive chain of mountains or mountain ranges, especially the principal mountain system of a continent.



[Spanish, from cordilla, diminutive of cuerda, cord
 Mountains forms its boundary on the east, Laguna de Bay Laguna de Bay (English translation: "Lake of Bay", commonly called as "Laguna Lake") is the largest lake in the Philippines and the 2nd largest inland freshwater lake in Southeast Asia after Lake Toba in Sumatra, Indonesia.  on the southeast, Central Luzon Central Luzon region contains the largest plain of the Philippines, and produces most of the country's rice supply. That is why it is called the "Rice Bowl" of the Philippines. Its provinces are: Aurora, Bataan, Bulacan, Nueva Ecija, Pampanga, Tarlac, and Zambales.  on the north and Southern Tagalog region on the south. Metro Manila is the general term for the metropolitan area that contains the cities of Manila, Caloocan, Las Pinas, Makati, Mandaluyong, Marikina, Paranaque, Muntinlupa, Pasay, Pasig, Malabon, Taguig, Valenzuela, and Quezon City Quezon City, city (1990 pop. 1,669,776), former capital of the Republic of the Philippines, central Luzon, a part of the Manila metropolitan area. A suburb of Manila, taken separately it would be the most populous city in the Philippines. . The municipalities of Metro Manila are Navotas, Malabon, Pateros and San Juan San Juan, city, Argentina
San Juan (săn wän, Span. sän hwän), city (1991 pop. 353,476), capital of San Juan prov., W Argentina. It is a commercial and industrial center in an agricultural region.
.

This study examines whether SMEs in Metro Manila comply with or do not comply with GAAP. This study also aims to determine the factors that influence SMEs in Metro Manila to choose between the two accounting methods--accrual and cash. This paper reports the results from the observations, which identify the method that is more applicable to these entities.

The relevance of developing a more comprehensive understanding is becoming more important, especially with the Exposure Draft of IFRS IFRS International Financial Reporting Standard(s)
IFRS Inter Frame Relay Service
IFRS Indiana Facilities Registry System
 for SMEs, final standards of which are expected to be issued by the International Accounting Standards Board An editor has expressed concern that this article or section is .
Please help improve the article by adding information and sources on neglected viewpoints, or by summarizing and
 (IASB IASB

See International Accounting Standards Board (IASB).
) in the second half of 2008. Most of the studies pertaining to accounting standards and practices applicable to SMEs have focused on developed countries (IFAC, 2006). No literature was found on the financial reporting of SMEs in the Philippines.

Consequently, this research is pioneering and due to non-availability of previous data, this study is limited to SMEs located in Metro Manila. Surveys were conducted and data were gathered from ten external auditors handling SME (1) (Small and Medium-sized Enterprise) See SMB.

(2) (Subject Matter Expert) An individual who is well-versed in the policies and procedures of a particular department or division.
 clients throughout Metro Manila. These auditors handle 163 SMEs in Metro Manila. The data gathered from the external auditors were corroborated by 17 SMEs in Metro Manila. Sample firms were taken from the list of 2007 registered SMEs in Metro Manila covering the cities of Paranaque, Pasig and Quezon.

While the number of SME respondents was low, given the reasons that the external auditors are the ones who prepare the financial statements for these SMEs, it was considered adequate as the responses from the external auditors suffice in meeting the objectives of the study.

Due to the limited number of observations in this study, regression analysis In statistics, a mathematical method of modeling the relationships among three or more variables. It is used to predict the value of one variable given the values of the others. For example, a model might estimate sales based on age and gender.  may not be implemented to test the hypotheses. However, this paper presents a regression model that will empirically test the hypotheses when provided with sufficient number of observations.

RELATED LITERATURE AND HYPOTHESES

Every so often, debate arises whether separate accounting and reporting rules should be set for SMEs (Sayther, 2004). The debate has risen as to whether SMEs should adopt a different set of accounting rules due to reasons such as differing needs of financial users, rapid and widespread developments in financial reporting, compliance costs, and statutory requirements (Mersereau, 2002).

GAAP are imposed on companies so that users have at least a minimum level of consistency in the financial statements they use when analyzing companies for various purposes. Accordingly, the constant evolution of GAAP, therefore, fulfills its mission to disseminate quality financial information. This information obtained from the financial statements, earnings in particular, facilitates investors' valuations and the monitoring of management.

Financial statements for business organizations must be prepared using the accrual accounting basis. This requirement is specified in Philippine Accounting Standards (PAS) 1: Presentation of Financial Statements. Likewise, Section 2.33 of the Exposure Draft of International Financial Reporting Standards International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB).

Many of the standards forming part of IFRS are known by the older name of International Accounting Standards (IAS).
 (IFRS) for SMEs requires the use of accrual basis A method of accounting that reflects expenses incurred and income earned for Income Tax purposes for any one year.

Taxpayers who use the accrual method must include in their taxable income any money that they have the right to receive as payment for services, once it
 of accounting.

However, Jankovic (2007) enumerated several reasons why the application of IFRS is inadequate. These are: (1) users of SMEs' financial statements need less information compared to the users of financial statements of listed companies; (2) particular transactions mentioned in IFRS occur seldom, if ever, in SMEs; (3) the cost/benefit ratio of financial reporting is more favorable in large companies than in SMEs; and (4) IFRS are prone to changes unlike national standards, which results in higher costs of IFRS implementation.

In a study made by Meagher (1982), small businesses claim that although they are conforming to the same accounting standards as large businesses, they argue in favor of a two-GAAP approach, one for large businesses and one for SMEs. The two-set model is consistent with accounting theory, better allows for congruence con·gru·ence  
n.
1.
a. Agreement, harmony, conformity, or correspondence.

b. An instance of this: "What an extraordinary congruence of genius and era" 
 with policies for SMEs, and ensures that standards reflect important differences and needs.

Furthermore, the Canadian Institute of Chartered Accountants The Canadian Institute of Chartered Accountants (CICA) is the umbrella body for the Chartered Accountant profession in Canada and Bermuda. Membership of the CICA totals 70,000 Chartered Accountants and 8,500 students.  (CICA CICA Competition In Contracting Act of 1984 (USA)
CICA Canadian Institute of Chartered Accountants
CICA Competition In Contracting Act
CICA Criminal Injuries Compensation Authority (UK) 
) Accounting Standards Board The role of the Accounting Standards Board (ASB) is to issue accounting standards in the United Kingdom. It is recognised for that purpose under the Companies Act 1985. It took over the task of setting accounting standards from the Accounting Standards Committee (ASC) in 1990.  commissioned a research to examine how the financial information needs of capital to SMEs might be more effectively met, and the degree to which reporting in accordance with generally accepted accounting principles could be modified to meet those needs (Lavigne, 1999).

The findings of the consultation process demonstrate that only one was acceptable to the SME financial reporting stakeholders consulted--the adoption of differential reporting principle within GAAP (Lavigne, 1999). According to according to
prep.
1. As stated or indicated by; on the authority of: according to historians.

2. In keeping with: according to instructions.

3.
 this principle, accounting rules governing SMEs would be permitted to differ from accounting rules applicable to public enterprises when such rules do not meet the financial reporting needs of SMEs or when the cost of applying the rules would outweigh their potential benefits for these enterprises (Martin, 2000).

This study poses the following research hypotheses:

[H.sub.1]: Nature of business is a factor that may influence SMEs in Metro Manila to choose between accrual and cash accounting.

Fundamentally, general-purpose financial statements are prepared on the assumption that there are no basic differences in the needs of those who will use them. However, accounts of small companies are prepared primarily for the benefit of owner-managers, their bankers and the revenue authorities who have little interest in the kind of information aimed at users of statements of public companies. The board of directors or other equivalent governing body Noun 1. governing body - the persons (or committees or departments etc.) who make up a body for the purpose of administering something; "he claims that the present administration is corrupt"; "the governance of an association is responsible to its members"; "he  controls the circulation of financial statements of non-public entities (Mersereau, 2002). Such financial statements are generally restricted to management and lending institutions.

Chan (2003) claimed that traditionally, some governments and businesses have used different accounting methods because they have different goals. Governments prefer to use cash-based accounting to manage and report revenue and spending to a certain period. The private sector, on the other hand, needs to manage financial performance.

Business firms that customarily receive cash advances from customers before the rendering of services or delivery of goods may well find that the accrual basis of accounting is advantageous (Jones & Luscombe, 2002). Churchill (1992) affirms that this method is also used by most corporate and many unincorporated bodies, such as societies, associations and clubs, small government departments, and professional firms because it provides an accurate picture of the company's current condition.

[H.sub.2]: Convenience in record keeping is a factor that may influence SMEs in Metro Manila to choose between accrual and cash accounting.

Carter (1981) affirmed that the choice between accrual-basis and cash-basis reporting of revenues provides an example of preference in the benefits sense. If a user of accrual-basis statements prefers that revenues be stated on a cash basis, he can simply ignore trade receivables and unearned fees on the balance sheet, and adjust reported accrual basis revenues by the differences between the year's beginning and ending balances in those two accounts, plus the reported uncollectible accounts expense. This calculation provides a cash-basis figure for revenues, and accommodates those users who prefer the cash basis than the accrual basis for reporting revenues.

[H.sub.3]: Complexity in accounting and disclosure requirements is a factor that may influence SMEs in Metro Manila to choose between accrual and cash accounting.

Tom Kelly People named Tom Kelly include:
  • Tom Kelly (baseball) (born 1950), former manager of the American baseball team the Minnesota Twins.
  • Tom Kelly (basketball) (born 1924), played in 27 games for the Boston Celtics in the 1948-49 NBA season.
 of American Institute of Certified Public Accountants (AICPA AICPA

See American Institute of Certified Public Accountants (AICPA).
) says that there is a widespread complaint that accounting standards were too big and too complicated for SMEs (Cheney, 1995). David Sun Tak-Kei, president of the Hong Kong Hong Kong (hŏng kŏng), Mandarin Xianggang, special administrative region of China, formerly a British crown colony (2005 est. pop. 6,899,000), land area 422 sq mi (1,092 sq km), adjacent to Guangdong prov.  Society of Accountants (HKSA HKSA Hong Kong Society of Accountants
HKSA Hong Kong Student Association
HKSA Hervormde Kerk in Suidelike Afrika (Reformed Church in South Africa)
HKSA Hong Kong Society of Arts
), believes that many of the accounting rules are tailored for large companies. Alerding (2003) stated that SMES have been caught in the wake of increasingly complex accounting and disclosure requirements following the wave of laws and new accounting pronouncements, resulting from the Enron scandals and similar frauds.

Churchill (1992) disclosed that the relative complexity makes it more expensive to implement. Hence, HKSA took the initiative to introduce accounting. standards tailor-made for SMEs in a bid to help them save time and money (Yiu, 2003).

Consequently, Financial Accounting Standards Board Financial Accounting Standards Board (FASB)

Board composed of independent members who create and interpret Generally Accepted Accounting Principles (GAAP).
 (FASB FASB

See: Financial Accounting Standards Board


FASB

See Financial Accounting Standards Board (FASB).
) continues to address the complexity of the GAAP hierarchy in the standards it has issued (Fitzsimons & Thompson, 2005). Meagher (1982) stated that SMEs in Canada conform to Verb 1. conform to - satisfy a condition or restriction; "Does this paper meet the requirements for the degree?"
fit, meet

coordinate - be co-ordinated; "These activities coordinate well"
 the same standards as large businesses but the way in which financial statements are being prepared, to them, is simply too complex. Thus, the Canadian Institute of Chartered Accountants considered three conceptually different accounting models: (1) a single set of GAAP without exclusions, essentially the status quo [Latin, The existing state of things at any given date.] Status quo ante bellum means the state of things before the war. The status quo to be preserved by a preliminary injunction is the last actual, peaceable, uncontested status which preceded the pending controversy. ; (2) a single set of GAAP with exclusions for SMEs; and (3) two distinct sets of GAAP. The primary rationale for the exclusions was to reduce SMEs compliance burden (Feltham & Mathieu, 2000).

[H.sub.4]: Tax compliance requirements Compliance requirements are a series of directives established by United States Federal government agencies that summarize hundreds of Federal laws and regulations applicable to Federal assistance (also known as Federal aid or Federal funds).  may influence SMEs in Metro Manila to choose between accrual and cash accounting.

The application of accounting standards to SMEs has revolved around one principal issue: whether the standards should apply equally to all financial statements that purport to present a true and fair view or whether small companies should be exempted from the unduly burdensome requirements of certain standards (Allister, 1995).

The U.S. released revenue regulations to ease the burdens of SMEs. Revenue Procedure 2000-22 allows any company, with tests to meet, to use cash method of accounting for tax purposes (Jennings, 2001). Revenue Procedure 2002-28 was issued in May 2002 to reduce administrative and tax compliance burdens and to minimize disputes over the use of the accounting method because on the requirement to account for inventories (Chiavetta, 2002).

[H.sub.5]: Cost of preparing financial statements is a factor that may influence SMEs in Metro Manila to choose between accrual and cash accounting.

In many cases, the cost of preparing those financial statements is increasing significantly. Sayther (2004) concluded that some companies chose to depart from certain GAAP requirements for them to limit compliance costs. It is believed that the costs of compliance with GAAP exceed the benefits for SMEs (Derieux, 1985).

In 2002, U.S. Small Business Administration reported that companies with 20 or less employees were spending an average of USD USD

In currencies, this is the abbreviation for the U.S. Dollar.

Notes:
The currency market, also known as the Foreign Exchange market, is the largest financial market in the world, with a daily average volume of over US $1 trillion.
1, 202 per worker to comply with federal financial reporting mandates. Such amount was more than twice the amount that companies was with more than 500 workers spent on compliance (Sayther, 2004).

In Canada, some companies opted to depart from certain GAAP requirements and settled on qualified audit or review reports, or moved from audited or reviewed statements to compilation engagements just to minimize the cost of engagements (Mersereau, 2002).

Carter (1981) claimed that gross benefit is achieved when the cost of producing and processing the unique information is ignored. He examined the continuing focus on benefits rather than costs of the reporting alternatives and argued that the identification of which of the alternatives fits a particular accounting policy decision should indicate costs of the policy choices.

[H.sub.6] : Usefulness in decision-making of the financial statements prepared is a factor that may influence SMEs in Metro Manila to choose between accrual and cash accounting.

A survey sponsored by American Institute of Certified Public Accountants (AICPA) revealed that respondents said that certain GAAP standards are not relevant and useful enough to help SMEs make management, credit, and investment decisions (Tie, 2005).

Simpson (1992) claimed that businesses rely on the accrual accounting method as the only source for management decision-making (Simpson, 1992). Meanwhile, in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. , owners of private companies argued that external users of financial statements do not utilize all the information contained in such reports. The extra costs incurred by such private entities were not worth the benefits received.

METHODOLOGY SMEs consider several factors that would influence them to choose between the two methods--accrual or cash--in the preparation of the entity's financial statements. The perspective of both the external auditors handling SMEs and the SMEs were sought to determine which between the two methods is more applicable to SMEs in Metro Manila. To measure the factors that may influence SMEs to choose between accrual and cash accounting, survey results were analyzed using five-point Likert scale Likert scale A subjective scoring system that allows a person being surveyed to quantify likes and preferences on a 5-point scale, with 1 being the least important, relevant, interesting, most ho-hum, or other, and 5 being most excellent, yeehah important, etc , with 5 as of the most effective level and 1 as the least effective level.

Surveys were conducted and data were gathered from ten external auditors handling SME clients throughout Metro Manila. These auditors handle 163 SMEs in Metro Manila. The data gathered from the external auditors were corroborated by 17 SMEs in Metro Manila. Sample firms were taken from the list of 2007 registered SMEs in Metro Manila covering the cities of Paranaque, Pasig and Quezon.

Due to the limited number of observations in this study, regression analysis may not be implemented to test the hypotheses. Simple descriptive statistics descriptive statistics

see statistics.
 were employed to analyze the limited data gathered. Nevertheless, considering that the external auditors are the ones who prepare the financial statements for these SMEs, the responses gathered from the external auditors suffice in meeting the objectives of the study.

However, if the researcher would have sufficient number of observations, or in the event that some researchers would gather additional information in the future, the following logistic model is suggested to be employed to quantify the results.

A Logistic Model for SME's Choice of Accounting Method

Considering that the choice of an accounting method is qualitative, the regression model involves dummy variable This article is not about "dummy variables" as that term is usually understood in mathematics. See free variables and bound variables.

In regression analysis, a dummy variable
. The dependent variable is a dummy variable, which takes on two values--the choice between accrual and cash accounting.

Let the dummy variable [Y.sub.i] be defined as:

[Y.sub.i] = 1 if ith SME chooses accrual method

[Y.sub.i] = 0 if ith SME chooses cash method

The focus of analysis would be in modeling the probability Pi of choosing the accounting method, given the perceptions represented by the independent variables [X.sub.1], [X.sub.2], ..., [X.sub.k] with:

[P.sub.i] = P [[Y.sub.i] = |[X.sub.2], [X.sub.3], ..., [X.sub.k]]

Based on the logistic regression model employed by Beasley (1996), and logit model as illustrated by Maddala (2001), the empirical model for influences to choose between accrual and cash accounting is:

ln [[P.sub.i] / (1-[P.sub.i])] = [b.sub.1] + [b.sub.2][X.sub.2] + [b.sub.3][X.sub.3] + .... + [b.sub.k][X.sub.k] + [m.sub.i]

where

[X.sub.2] = nature of business, which refers to the kind of business of SMEs.

This is a categorical independent variable coded "1" through "5", scale to answer the statement, "We consider the nature of our business in choosing the accounting method applied". It is quantified as follows: 5-strongly agree; 4-agree; 3-neutral; 2-disagree; and 1-strongly disagree.

[X.sub.3] = convenience, which refers to the level of burden in record-keeping.

This is a categorical independent variable coded "1" through "5", scale to answer the statement, "We consider the convenience in record-keeping to choose between accrual and cash accounting". It is quantified as follows: 5-strongly agree; 4-agree; 3-neutral; 2-disagree; and 1-strongly disagree.

[X.sub.4] = complexity, which refers to the burden of accounting and disclosure requirements in reporting to regulatory bodies.

This is a categorical independent variable coded "1" through "5", scale to answer the statement, "We consider the complexity of accounting and disclosure requirements in choosing between accrual and cash accounting method". It is quantified as follows: 5-strongly agree; 4-agree; 3-neutral; 2-disagree; and 1-strongly disagree.

[X.sub.5] = tax, which refers to the tax compliance burden.

This independent variable can be measured in terms of ratio to revenues during the period.

[X.sub.6] = cost, which refers to the cost of preparing the financial statements.

This independent variable can be measured in terms of ratio to revenues during the period.

[X.sub.7] = usefulness, which refers to the valuation of firms of the accounting method with respect to the characteristics of consistency and comparability for decision-making.

This is a categorical independent variable coded "1" through "5", scale to answer the statement, "Usefulness in decision-making of the financial statements prepared is a factor to choose between accrual and cash accounting". It is quantified as follows: 5-strongly agree; 4-agree; 3-neutral; 2-disagree; and 1-strongly disagree.

[[mu].sub.i] = the error term.

This multivariate logistic regression analysis will be employed because it enables to investigate the probability of an event's occurrence in relation to a number of measurable independent variables, with the estimation allowing one to compare the relative importance of each of the variables. This logistic model provides the ratio of probability that accrual was chosen over the probability that cash method was chosen. It expresses the natural logarithm Natural logarithm

Logarithm to the base e (approximately 2.7183).
 of odds ratio of the two events--accrual and cash method.

Logit model regression will be used because the dependent variable is dichotomous di·chot·o·mous  
adj.
1. Divided or dividing into two parts or classifications.

2. Characterized by dichotomy.



di·chot
. In addition, the regression analysis will control for differences in influences for SMEs to adopt the chosen accounting method.

RESULTS AND DISCUSSION

Seventy-six percent of the SME respondents use the accrual method while six percent of them use cash method for record keeping, and regularly converts to accrual method for purposes of reporting to regulatory bodies. The remaining eighteen percent, however, use cash method, and the external auditors are tasked to prepare year-end adjustments using accrual method in accordance with GAAP.

From the limited data in this study, which were analyzed using simple descriptive statistics, the following were the results on the factors that influence SMEs to choose between accrual and cash accounting method.

Nature of Business

The nature of the business of the sample SMEs and the clients of the external auditors in this study is scattered across the business of construction, trading, pharmaceutical distribution, real estate, restaurant, communication, printing, and garment manufacturing. Unanimously, SMEs and the auditors strongly agreed ("5") that the nature of business is a factor that influenced SMEs in choosing the accounting method applied. SMEs involved in financing/pawnshops, real estate, construction, and restaurants apply the cash method. Cash basis is generally used when it is difficult to determine the revenue amount at the time of a credit sale because collection is uncertain.

On the other hand, SMEs with the nature of business such as printing, trading, transportation services, and manufacturing concerns like garments use accrual method. Some of these firms customarily receive cash advances from customers before they render services or deliver goods and find accrual method advantageous. In addition, reporting accounts under this method helps them in planning the operating cycle Operating cycle

The average time between the acquisition of materials or services and the final cash realization from that acquisition.


operating cycle 
, especially in the management of inflow and outflow of cash.

Convenience

Seventy percent of the practitioners strongly agreed ("5") that the accounting method chosen by their clients was due to the convenience in record keeping, while 30 percent of the practitioners disagreed ("2") that convenience is one of the factors why their clients chose their adopted accounting method. This was corroborated by the SMEs as 76 percent of them strongly agreed ("5") that convenience was a factor considered in adopting the chosen accounting method. Twenty four percent of the SMEs, on the other hand, disagreed ("2") with the statement.

Complexity

Fifty percent of the external auditors disagreed ("2") that complexity in accounting and disclosure requirements is one of the factors why their clients chose their adopted accounting method. Likewise, 70 percent of the SMEs disagreed ("2") with the statement. Forty percent of the external auditors and 24 percent of the SMEs strongly disagreed ("1"). Ten percent of the auditors and six percent of SMEs answered neutral ("3"), which means that to them, the two methods are equal in terms of complexity in reporting and disclosure requirements and this may or may not affect their choice of accounting method.

Tax Compliance Burden

For the purpose of this study, this is a categorical independent variable that was measured using Likert Scale "1" through "5", to answer the statement, "We consider the tax compliance burden in choosing between accrual and cash accounting method". It is quantified as follows: 5-strongly agree; 4-agree; 3-neutral; 2-disagree; and 1-strongly disagree.

Seventy percent of the external auditors disagreed ("2") that tax compliance burden is one of the factors why their clients chose their adopted accounting method. These perspectives were validated by 76 percent of the sample SMEs. However, 30 percent of the auditors and 24 percent of the SMEs claimed that tax compliance burden have the same weight under the two methods and answered neutral ("3).

Cost

For the purpose of this study, this is a categorical independent variable that was measured using Likert Scale "1" through "5", to answer the statement, "We consider the cost of preparing the financial statements in choosing between accrual and cash accounting". It is quantified as follows: 5-strongly agree; 4-agree; 3-neutral; 2-disagree; and 1-strongly disagree.

Twenty percent of the practitioners strongly disagreed (1) to the statement that cost of preparing financial statements is a factor in choosing between the two methods, and 18 percent of the SMEs validated the perspectives of the auditors. Forty percent of the external auditors disagreed (2) to the statement while thirty percent of them answered neutral (3), which means that to them, cost may or may not be a factor that influence the choice of accounting method. Meanwhile, 76% of the SMEs disagreed (2) to the statement. The remaining ten percent of the external auditors agreed (4) that cost is a factor, which was corroborated by six percent of the sample SMEs.

Usefulness in Decision-Making

Sixty percent of the practitioners strongly agreed ("5") that usefulness in decision-making of the financial statements prepared is a factor that influenced their SME clients to choose between the two methods. Fifty-eight percent of the SMEs also strongly agreed ("5") to the statement. Thirty percent of the practitioners agreed ("4") and eighteen percent of the SMEs claimed the same. Ten percent of the practitioners whose clients use the cash method stated that their clients did not consider this variable in choosing the accounting method. Thus, they disagreed ("2"), which was validated by 24 percent of the SMEs.

Other Factors

The respondents were asked to specify other factors that are considered in choosing the accounting method applied. The practitioners consider the method that better reflects the true financial condition of their clients. They consider the method that applies the principle of proper recognition of income, and the principle of matching the revenue recognized with the expenses incurred for the period.

On the other hand, sample SMEs consider the method that is required by Bureau of Internal Revenue. In addition, SMEs consider the method that will be able to produce schedules that support the revenue during the period.

Applicability of the Accrual Method

The respondents were asked regarding the applicability of accrual method, as prescribed by GAAP. The following are the comments of the respondents:

From the Perspective of External Auditors

The accrual method is applicable to SME clients because: (a) it reflects better the true financial condition of the company; (b) clients need a real picture of the business to be used as a tool in decision-making; (c) of complete monitoring of actual transaction of the business operation and for internal control purposes; (d) it reflects the net income for the period; (e) accrual gives a more accurate picture of the companies financial situation than cash method; (f) it is needed for financial reporting purposes; (g) of the nature of the business; (h) it captures correct charging of expenses at the period when revenue is earned; and (i) of the matching principle of cost and revenue.

Meanwhile, the accrual method is not applicable to SME clients because: (a) of tax purposes, as in Accrued Income already earned but not yet received, the client pays taxes on this income though not yet received; and (b) the client needs to withhold taxes on expenses recognized in the books, although accrued expenses can be part of allowable deductions even if not yet paid.

From the Perspective of SMEs

The accrual method is applicable to SMEs because: (a) it provides a more realistic and accurate analysis of how the company is performing; (b) it reflects the true financial condition of the firm; (c) it is mandatory; and (d) it is in accordance with accounting standards.

Meanwhile, the accrual method is not applicable to SMEs because of tax purposes.

CONCLUSION

From the limited data and results gathered, the following conclusions are drawn:

1. Some SMEs in Metro Manila do not adhere to accrual accounting as prescribed by GAAP.

2. Consistent with the previous studies, the factors that influence SMEs to adopt either accrual or cash accounting are the nature of business, convenience in record keeping, and usefulness in decision-making of the financial statements prepared under the chosen method.

3. In contrast to previous studies, complexity in reporting and disclosure requirements, tax compliance burden, and cost of preparing financial statements are not factors that influence SMEs to choose between accrual and cash accounting.

Results from the survey show that SME uses cash method if the firm is engaged in real estate, financing/pawnshop, real estate, restaurant and construction. On the other hand, accrual method is used when an entity is engaged in trading, printing, transportation, and manufacturing concerns like garments.

The objective of financial statements is to provide information that is useful to a wide range of users in making economic decisions. From the data gathered, cash accounting is used for tax reporting purposes and accrual accounting is for financial reporting purposes. Some SMEs use cash method because they prepare financial statements primarily for tax authorities, rather than for investment and credit decision making.

In contrast, some SMEs rely on accrual accounting as the only source of information for management decision-making. Financial statements prepared under the accrual method are intended to meet the needs of investors, lenders, creditors, rating agencies, employees, customers, and others outside the business. The general-purpose financial statements serve the managers' needs by providing insights into the business's financial position, performance and cash flows.

Financial statements should be understandable, relevant, reliable, and comparable. Accrual accounting incorporates non-cash information such as revaluations, write-offs, the consumption of assets through depreciation, and pension liabilities Pension liabilities

Future liabilities resulting from pension commitments made by a corporation. Accounting for pension liabilities varies widely by country.
. Accrual is based on the idea of accurately presenting a firm's earned income, that is, the actual economic results of its activities, not the cash result of its activities.

The researcher claims that cash-based information has the advantage of being relatively simple and readily verifiable. However, non-cash costs or revenues are not recorded. Non-cash accounts such as receivables and payables arising from the ordinary course of the business are not recorded. Hence, cash basis of accounting does not provide a complete financial picture of the SME the same way the accrual method does. Therefore, information provided under the cash method may not pass the qualitative characteristics of being relevant and reliable. Users of financial statements should be therefore careful in making economic decisions based on the information provided using cash accounting.

Accrual accounting, in contrast to limitations of cash accounting, meets the objectives of the financial statements for being reliable, relevant, understandable, and comparable.

Consequently, despite some difficulties argued by SMEs in using accrual method, they find more advantages in using this method than in the cash method, as evidenced by the 76 percent of the SMEs in this study that use the accrual method.

Therefore, the researcher posits that accrual accounting is more applicable than cash accounting for SMEs in Metro Manila. Hence, the provision of Section 2.33 of the Exposure Draft of IFRS for SMEs that requires the use of accrual basis of accounting is applicable to SMEs in Metro Manila.

RECOMMENDATION

Due to the limited number of observations in this study, regression analysis may not be implemented to test the hypotheses. Readers are cautioned to interpret the findings of this study in the light of this limitation. However, this paper presents a logistic model that will empirically test the hypotheses when provided with sufficient number of observations. This paper then suggests collection of more data and the use of the regression model for future researches.

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Cynthia P. Cudia, De La Salle De La Salle is the name of several educational institutions affiliated with the Institute of the Brothers of the Christian Schools, also known as the Lasallian Brothers, a Roman Catholic religious teaching order founded by French priest Saint Jean-Baptiste de la Salle:
 University--Manila
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Author:Cudia, Cynthia P.
Publication:Journal of International Business Research
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Date:Mar 1, 2008
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