Cash Basis and Accrual Basis Accounting-Definition, Features, Example, and Difference [Notes with PDF]
In this article, we will learn in detail about cash basis and accrual basis accounting including their definition, features, example, differences, and many more.
So, let’s get started.
Basis of Accounting
There are two accounting methods for recording business transactions such as income and expenses, as well as calculating profits. The first is cash basis accounting, and the second is accrual basis accounting.
The two methods are described further below.
What is Cash Basis Accounting?
In this accounting method, a transaction is only recorded if it involves the receipt or payment of cash. In contrast to any other transaction, the transaction is only recorded in the ledger when cash is received or paid in cash.
In practice, arrears of income or expenses are incurred in addition to cash, but arrears of income or expenses are not accounted for in this case.
As a result, cash-based concepts often have incomplete financial statements, because all income earned but not received is not accounted for on a cash basis. This is a violation of the revenue recognition policy.
Again, arrears or advance expenditures are not matched against income, which is the opposite of the matching policy, which is contrary to the universally accepted accounting principles. As a result, the organization has no assets other than cash.
Features of Cash Basis Accounting
The essential features of cash basis accounting are as follows:
- This system only keeps track of actual cash receipts and payments.
- It does not keep track of outstanding transactions such as expenses and income.
- This system does not keep a complete record of financial transactions during a trading period.
- This system is unable to disclose the correct profit or loss as well as the true financial position of the company.
- The generally accepted accounting principles (GAAP) are not followed by cash-basis accounting.
- Individuals and a few small businesses, on the other hand, use cash-basis accounting.
Example of Cash Basis Accounting
Assume, an organization paid $6,000 in rent for the month of December and still owes $2,000 in rent.
So, according to cash basis accounting, the total rent expense for the month of March will be $6,000.
What is Accrual Basis Accounting?
This method is a complete complement to the double-entry accounting system because it is considered income as soon as the right to income is created in the case of transactions during the accounting period.
It is not important when the income will be received here. Similarly, when liability arises in the case of expenditure, it is treated as an expense.
In fact, the main purpose of this method is to account for the accounting period’s receipts and receivables as well as payments and payables in the preparation of the income statement and balance sheet.
As a result, the organization’s actual profit and financial condition can be displayed. All assets are displayed separately in this method.
Features of Accrual Basis Accounting
The essential features of accrual basis accounting are as follows:
- In this system, all transactions for a period are recorded in the account books.
- Both cash and accrual transactions are recorded by this system.
- This system provides a complete picture of the company’s financial transactions.
- This system can disclose the correct profit or loss as well as the company’s true financial position.
- Accrual-basis accounting follows GAAP.
- Accrual-basis accounting is used by medium and large businesses.
Example of Accrual Basis Accounting
Assume, an organization paid $6,000 in rent for the month of December and still owes $2,000 in rent.
So, according to accrual basis accounting, the total rent expense for the month of March will be $6,000 + $2000 = $8,000
Difference between Cash Basis and Accrual Basis Accounting
The twelve important differences between cash-basis and accrual-basis accounting are as follows:
| Sl. No. | Subject of Difference | Cash Basis Accounting | Accrual Basis Accounting |
| 1. | Definition | Cash basis accounting is a method of accounting that records only cash income and expenditure. | Accrual-basis accounting is a method of accounting that records both cash and accrual income and expenditures. |
| 2. | Accounting Period | It only considers cash receipts and payments; the accounting period is not taken into account. | It records both cash and accrual transactions for the respective accounting period but does not take into account receipts or payments from any other accounting period. |
| 3. | Determination of Profit and Loss | Profit and loss are calculated using only cash income and cash expenditures in this method. | Profit and loss are calculated using this method by taking into account both cash and arrears income and expenditure. |
| 4. | User | Cash-basis accounting is commonly used in government offices and among professionals. | Accrual-basis accounting is used in both business and non-profit organizations. |
| 5. | Information completeness | It does not contain complete information. This is because it does not include arrears transactions from the accounting period. | It provides comprehensive accounting information. It contains all cash and arrears transactions for the accounting period. |
| 6. | Acceptability | This method is not internationally acceptable. | It is internationally accepted. |
| 7. | Application | This method is appropriate for small businesses. Furthermore, it is appropriate for any organization that only conducts cash transactions. | This method is recognized as an ideal method for all small and large organizations. Furthermore, this method is useful in all institutions where cash and credit transactions are conducted. |
| 8. | GAAP | This method does not allow for the application of GAAP. | In this manner, Universally Accepted Accounting Principles (GAAP) can be applied. |
| 9. | Comparative Analysis | The accounts are not kept in their full form in this method. As a result, comparative analysis of many important data points is impossible. | A comparative analysis is possible since the complete account information is saved and various statements are generated from the stored information. |
| 10. | Adjusting Entries | In this method, there is no need for adjusting entries, so it does not properly display the adjusted accounts. | In this method, proper accounting is shown through adjusting entries. |
| 11. | Assets display | There are no assets other than cash. | All other assets, including cash. |
| 12. | Basis of the transaction | This method is used to keep track of accounts in institutions where the majority of transactions are made in cash. | This method is used to keep track of accounts in institutions where the majority of transactions are made on credit. |
Why is The Accrual Basis Accounting Better Than The Cash Basis Accounting?
The majority of transactions in today’s world are credit-based. Because of this, the majority of commercial enterprises use the accrual basis of accounting. When compared to the cash basis of accounting, the accrual basis of accounting has the following advantages:
- According to generally accepted accounting principles (GAAP), cash basis accounting is not acceptable. It does not follow the matching principle, the accounting periodicity concept, or the revenue recognition principle. Contrarily, the accrual basis complies with GAAP.
- The cash basis of accounting frequently presents us with an inaccurate picture of the financial outcome because it doesn’t record revenues for periods for which cash wasn’t received and expenses for which cash wasn’t paid. When using the accrual basis of accounting, there is no issue.
So we can say that accrual-basis accounting is better than cash-basis accounting.
You can also read:
- Adjusting entries; Definition, Examples, Types Necessity, Format [With PDF]
- 40 Important Adjusting Entries [With PDF]
- Best Way to Identify Business Transaction [With PDF]
