Basis of Accounting- Cash and Accrual Basis of Accounting

Today we discuss about the Basis of Accounting -Cash and Accrual Basis of Accounting . Accounting is concerned with recording of the financial transactions(which can be measured in terms of money), this deals with the timing of revenue recognition which means when should the revenue be recognized in the books of accounts. There are two approaches of recording the revenues in the books of accounting- Cash basis of accounting and Accrual basis of accounting. Let us discuss and find out the information about Basis of Accounting.

Meaning of Cash Basis of Accounting

Under Cash Basis of Accounting the transactions are recorded when cash is received or paid. This system is much more simplified accounting system, cash basis of accounting only recognizes income and expenses, when cash is actually collected and paid. Cash basis of accounting is an accounting system that recognizes and records income and expenses as they are paid or received in cash.

In this system of accounting an Income is only recorded when it comes in, this means an income will be earned by business when it is received in cash and similarly the expenses will also be recorded only when they actually paid by the business. Let us further understand this with below examples-

• ABC Ltd. pays rent of the commercial office for the month of October on 05 November, this expense of rent recorded in November although the rent is for the month of November but in the books of accounts it is recorded as an indirect expense in November as per Cash Basis of Accounting because the asset i.e, cash of Enterprise is reduced in November.

• Gupta Stationers sold goods on credit on 02 July on the payment terms of 30 days. They received the payment after the completion of 30 days i.e, 01 August. This receipt or income is recorded in the month of August, in the books of accounts because payment is received in August no matter in which month sale was made.

👉Also read Difference between Bookkeeping and Accounting
👉Also read Generally Accepted Accounting Principles of Accounting
👉Also read Systems of Accounting and AIS
👉Also read International Financial Reporting Standards(IFRS)
👉Also read Generally Accepted Accounting Principles of Accounting

Advantages of Cash Basis of Accounting

• Simple- It is a simplest basis of accounting as adjustments  for outstanding expenses, prepaid expenses, accrued income and income received in advance is not made. Accounts preparation would become simpler as businesses will not have to make  accounting adjustments in the end of the year like adjustments for Debtors, creditors, inventories etc.

• Suitability- This basis of accounting is suitable for those enterprises where most of the transactions are on cash basis, like where the organization are very small or in the case of individuals.

• Reliability- Reliability is increased because transactions are recorded only when all transactions are fully completed and payment takes place. This approach is more objective as  very few estimates and less judgements are required.

Disadvantages of Cash Basis of Accounting

• Cash Basis of Accounting is not fully exact- It does not give a true and fair view of the profit or loss and the financial performance of an enterprise because it ignores outstanding and prepaid expenses and accrued income advance incomes.

• It does not follow the matching principle of Accounting- Cash basis of accounting is a good approach of tracking cash inflow and cash outflow but it does not follow the matching principle of Accounting ,it is necessary to match the incomes of the period with expenses of that same period to determine correct profit/loss for the accounting period. Profit earned by the business during a period can be correctly measured only when the incomes and revenues are matched with the expenses incurred to earn that income during the accounting period. Simple cash accounts will not give a true picture of business position.

• It eliminates consistency- Cash accounting basis of accounting does not distinguish between capital and revenue items, as a result, there is no consistency in the profits if two years.

Meaning of Accrual Basis of Accounting

Under accrual basis of accounting the transactions are recorded when incurred, in accrual basis of accounting the revenue and expense of business is recorded in the books of accounts when it is earned or incurred. Whereas in the system of cash basis, transactions are recorded only when cash is collected or paid. Total amount of revenues and expenses are shown in the financial statements, whether or not cash received or paid for those transactions in the period of time.

Accrual Basis of accounting is based on the concept of realisation and expiration and follows two basic accounting principles, i.e., Revenue recognition and Matching principle. Under Accrual basis of accounting, outstanding and prepaid expenses are adjusted. Similarly, accrued income and advance income are recognized for ascertaining correct profit or loss for the accounting period. For Example- 

• GS Infotech sell their goods to Vandana Associates on 20 April on the payment terms of 15 days, after the completion of 15 days payment is received by GS Infotech on 05 May. This revenue is recorded by GS Infotech in the month of April because the sales was incurred in the month of April, no matter when would be the cash is received.

Advantages of Accrual Basis of Accounting 

• It provides an accurate picture of financial transactions- In accrual basis of accounting revenues and expenses recorded immediately, while in cash basis of accounting the revenue shall not be recorded until the payment was received. This basis of accounting shows a complete record of financial transactions of the business because all transactions related to a period as well as adjustments like outstanding expenses, prepaid expenses, accrued income and advance income are recorded in the books of accounts.

• Acceptability- This bases of accounting calculates correct profit or loss for a particular period and also shows the true financial position of the business.It reflects true profit or loss during the accounting period and therefore has wide acceptability, this system is followed by most of the industrial and commercial firms.

• Preference- It is more scientific as compared to cash basis of accounting and also preferred by accountants because it gives a true and fair view of financial transactions.

• Compliant with GAAP- The Generally Accepted Accounting Principals(GAAP) prefers accrual accounting rather than cash basis of accounting because the financial statements of an enterprise that uses accrual basis of accounting deemed  to be more accurate because the transaction reflect in the books of accounts when they actually took place instead of when money is exchanged on behalf of transactions.

Disadvantages of Accrual Basis of Accounting

• Complex- This system is not as simple like Cash Basis of Accounting because this process is too elaborate and requires adequate skills, as we discussed above,  this basis of accounting shows a complete record of financial transactions of the business because all transactions related to a period as well as adjustments like outstanding expenses, prepaid expenses, accrued income and advance income are recorded in the books of accounts in a systematic order.

• It leads to some difficulties- A quick appraisal of the profit/loss is not possible under accrual basis of accounting because many adjustments like outstanding expenses, prepaid expenses, accrued income and advance income are required to ascertain the true financial position of the business.

• Time consuming- Accrual base of accounting requires the company to spend more time in reviewing the transactions, companies which use accrual basis of accounting need to analyse their account on daily basis or monthly basis. These companies need to determine the activities which have to be recorded in the books of accounts because they occurred  even though financial exchange took place or not.

Difference between Cash Basis of Accounting and Accrual Basis of Accounting

Basis	Cash Basis of Accounting	Accrual Basis of Accounting
Meaning	In this system of accounting an Income is only recorded when it comes in, this means an income will be earned by business when it is received in cash and similarly the expenses will also be recorded only when they actually paid by the business.	Under accrual basis of accounting the transactions are recorded when incurred, in accrual basis of accounting the revenue and expense of business is recorded in the books of accounts when it is earned or incurred. Whereas in the system of cash basis, transactions are recorded only when cash is collected or paid.
Nature	Simple	Complex
Degree of Accuracy	Low	Comparatively high
Profit or Loss	Correct profit or loss is not ascertained because it records only cash transactions.	Correct profit or loss is ascertained because it records both cash and credit transactions.
Acceptability	Cash basis of accounting is not acceptable in business as it does not reveal the required information.	Accrual basis of accounting is more acceptable because it reveals correct income and expenses besides assets and liabilities.
Reliability	Cash basis of accounting is less reliable because it records only cash transactions and as a result does not reveal correct profit or loss and not determine exact figure of assets and liabilities.	Accrual basis of accounting is more reliable as compared to cash basis of accounting because it records both cash and credit transactions, thus reveals correct profit or loss besides assets and liabilities.
Recognition of Revenue	When cash is paid, then revenue is recognized in the books of accounts	When expense is incurred, then revenue is recognized in the books of accounts
Technical Knowledge	Cash basis of accounting does not require much of technical knowledge as compared to Accrual basis of accounting.	It requires technical knowledge as many adjustments like prepaid, outstanding, capital and revenue are required to be made.
Matching Principle of accounting	Not followed by Cash basis of Accounting.	Followed by Accrual basis of Accounting.

Hey guys I hope you understand the concept of Cash basis of Accounting and Accrual Basis of Accounting, Accrual basis of accounting can be complex and difficult to manage but give a true view  of Financial Performance but Cash basis of accounting is  simple to manage but it does not give fully exact view of Financial position. I tried to cover all the concept of Cash basis of Accounting and Accrual Basis of Accounting. If you have any questions regarding this topic then please write in the comment section. Have a nice day, Thanks...