Cash Basis and Accrual Basis of Accounting
1. Under cash basis of accounting, revenue and expense recognition would occur when cash is received and disbursed. Contrast cash basis of accounting with accrual basis. Give suitable examples. ACCRUAL BASIS OF ACCOUNTING – An accounting basis wherein revenue and expenses are recorded in the period in which they are earned or incurred regardless of whether cash is received or disbursed in that period. This is the accounting basis that generally is required to be used in order to conform to generally accepted accounting principles (GAAP) in preparing financial statements for external users.
CASH BASIS OF ACCOUNTING – The accounting basis in which revenue and expenses are recorded in the period they are actually received or expended in cash. Use of the cash basis generally is not considered to be in conformity with generally accepted accounting principles (GAAP) and is therefore used only in selected situations, such as for very small businesses and (when permitted) for income tax reporting.
In simpler terms, Accrual Basis accounting will record an item as an expense if a firm incurs debt that is to be paid off at a later date; it will likewise assume an item as revenue if a counter party agrees to pay the firm on a later occasion. This is unlike the Cash Basis Accounting method, which ignores pending inflows and outflows of cash and instead records them when cash is received and paid out. To put it as simply as possible, accrual accounting adds income as it’s accrued (earned) Cash basis doesn’t add income until it is actually received.
If a company gives a customer a product that they will actually pay for later, the income is entered into their accounting ledger even though payment has not yet been received. This is accrual accounting. It has the advantage of tracking upcoming expenses and income for better future planning. In Cash Basis all accounting is done strictly on the actual movement of cash or cash value in an account. It is simpler and does not recognize promises to pay or debts owed as either expenses or income.