Accrual Basis Accounting Versus Cash Basis Accounting

Cash Basis Accounting

In a cash basis accounting the revenue is recognized when cash is received by the accountant and the expenses is recognized when it is paid. Cash basis accounting is considered as an incomplete accounting basis that does not reflect the actual financial position of the company. This basis of accounting does not recognize Accounts Receivable and Accounts Payable of the company.

Cash Basis Accounting is used in a small organization where management usually concentrate on a cash movements of the company.

The advantage of cash basis accounting is, this basis is much easier of managing the cash flow of the company by merely checking the bank balance rather having to scrutinize the accounts receivable and accounts payable. A business which maintains accrual basis accounting also have to perform cash flow analysis for its proper cash management.

Cash Basis accounting is not used in the preparation of a company’s Balance Sheet and Income Statement. This is used in a club, societies and other small entities. In a cash basis accounting, only the cash impact of a transaction is recorded.

Example of the impact are as follows:

  • Sales are recorded in the period in which the sellers receives full payment. For credit sales this will delay the recognition of the transaction.
  • Purchase are recorded in the period in which goods are paid for rather than the period in which the goods are purchased. For credit purchases this delay the recognition of the purchase.
  • The purchase of a capital asset is treated as a cash outflow at the point that cash consideration is paid. No subsequent adjustment is made for depreciation as this has no impact on the cash balance of the business.

Accrual Basis Accounting

Under this method, transactions are recognized when they occur, not when the related cash flows into or out of the entity.

Example of Accrual Basis Accounting are as follows:

  • Sales are recorded in the period when the risks and rewards of ownership pass from seller to buyer, not when the seller receives full payment. When credit sales are recognized, a receivable is set up in the entity’s books.
  • Expenses are recognized in the period when the goods or services are consumed, not when they are paid for. When credit purchase is recognized Accountant Payable is set up in the entity’s book
  • Non-Current Assets is recognized over the period during which they are used by the entity i.e. the asset is depreciated, not in the year of purchase as they would be under the cash basis of accounting.

Financial Statement i.e Balance Sheet and Income Statement are prepared on the basis of accrued accounting as this basis clearly the financial pictures of the company.