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Accounting Methods [Cash Basis & Accrual Basis]

There are two accounting methods from the point of view of the timing of recognition of revenue and expense, These are:

  1. Cash Basis of Accounting
  2. Accrual Basis of Accounting

The accounting methods measure the operating performance of the business during the accounting period.

accounting methods [cash basis and accrual basis

1. Cash Basis of Accounting

The cash basis of accounting is the practice of accounting for revenues in the period in which cash is received and for expenses in the period in which cash is paid.

Under the cash basis, You make entries for transactions in the book of accounts when you receive or pay cash and not when the receipt or payment becomes due.

for example,

If office rent for the month of May 2019, is paid in July 2019, it would be recorded in the book of account only in July 2019.

Similarly,

Sale of goods on credit in the month of January 2019 would not be recorded in January but say in April, when the payment for the same is received.

As a basis for measuring performance for a particular accounting period, the cash basis of accounting does not adequately match the cost of the efforts required to generate inflows with the inflows themselves. Cash outflows of one period can relate to operating activities whose cash inflows occur in preceding or succeeding periods.

Thus this system is incompatible with the matching principle, which states that the revenue of a period is matched with the cost of the same period.

2. Accrual Basis of Accounting

In the accrual accounting, revenues and expenses are recorded when they are earned or incurred rather than when they are received or paid.

Under this accounting method, You make entries for transactions in the book of accounts when the receipt or payment becomes due.

In simple words, expenses are recorded as when the liability to pay arise. Revenue is recorded as when the right to receive is established

Thus, under this system, the monitory effect of a transaction is taken into account in the period in which they are earned rather than in the period in which cash is actually received or paid by the enterprise.

The accrual basis of accounting provides a better measure of operating performance than the cash basis of accounting because the revenue of a period is matched with the cost of the same period.

The accrual basis of accounting is also called the mercantile system of accounting.

Comparison between the Cash Basis and the Accrual Basis

Cash Basis Accrual Basis
Using the cash-basis, revenue is only recorded when the cash is actually received
Under Accrual basis, revenue is recorded when it’s earned.
In cash accounting, expense is only recorded when the cash is actually paid.
In accrual accounting, exepense is recorded when it becomes due.
The cash-basis is quite simple to understand and maintain.
The accrual basis is more complicated to understand and maintain.
The cash basis is incompatible with the matching principle.
The accrual accounting method properly applies the matching principle.

The following graphic may help explain the difference between both the accounting methods i.e. cash basis and accrual basis.

difference between cash basis and accrual basis

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