There are two methods for recording accounting transactions such as cash basis and accrual basis. The accrual basis and cash basis accounting are two different accounting methods. The main difference between the two methods is in the timing of transaction recordation. In aggregated over time, the results of these two methods are approximately the same.
Accrual Basis and Cash Basis
Cash Basis Accounting
As per cash basis of accounting, we record revenues on receipt of cash, and expenses on their payment. Cash basis of accounting does not recognize accounts receivable or accounts payable.
All transactions related to revenues, costs, assets, and liabilities are reflected in the accounts for the period in which actual receipts or actual payments are made.
Many small enterprises opt to use the cash basis of accounting. It is simple to maintain. We can easily find out when a transaction has occurred and there is no need to track receivables or payables.
The cash method also helps to determine how much cash the business actually has at any given time. We can look at our bank balance and understand the exact resources at our disposal.
Learn more about System and Basis of Accounting here in detail.
Accrual Basis Accounting
As per accrual basis, we record revenues and expenses when they accrue, regardless of the actual receipt or payment of the amount. This basis is more commonly in use than the cash basis.
The accrual basis provides a more realistic idea of income and expenses during a period of time. This method provides a long-term picture of the business that cash accounting cannot provide.
The downside of this method is that accrual accounting does not give any awareness of cash flow. An enterprise can appear to be more profitable while in reality, it has no balances in bank accounts.
Accrual basis accounting without careful monitoring of cash flow can have potentially adverse consequences.
Difference between Accrual Basis and Cash Basis of Accounting
|Basis of Difference||Accrual Basis||Cash Basis|
|1.Prepaid&Outstanding Expenses / accrued &unaccrued Income in financial statements.||Under this, there may be prepaid or outstanding expenses and accrued and unearned incomes in the Balance Sheet.
|Under this system, there is no prepaid or outstanding expenses or accrued or unearned incomes.|
|2. Variations of Income in case of prepaid expenses and accrued Income.||Under this basis, income Statement will show a
relatively higher income
|Under this basis, income Statement will show lower income.|
|3. Variations of income in case
of outstanding expenses and
|Under this basis, income Statement will show a
relatively lower income.
|Under this basis, income Statement will show higher income.|
|4. Availability of options to an
accountant to manipulate the
accounts by way of choosing the most appropriate method out of several alternative methods of accounting.
|Under this basis, an accountant has options.||Under this basis, an accountant has no option to make a choice as such.|
Hybrid or Mixed Basis
Under the hybrid system of accounting, incomes are recognized similar as in Cash Basis Accounting i.e. when income is received in cash and expenses are recognized similar as in accrual basis i.e. during the accounting period in which expenses arise irrespective of when they are paid.
Solved Example for You
According to the cash basis, we record income and expenses in books of accounts:
(a) when income and expenses accrue.
(b) when income and expenses are received.
(c) when income is received and expenses are accrued.
(d) None of the above.
Ans: (b) Because in cash basis we record the transactions when it actually occurs.