A Comprehensive Study on Cash and Accrual Basis of Accounting
Hey there! TallyDekho brings a comprehensive study on the cash and accrual basis of accounting, one of the most discussed topics in a business organization. In this article, we’ll understand both methods of accounting, i.e, cash, and accrual in detail helping the businesses in making more accurate decisions.
In a business organization, the financial statements that your accountant prepares follow any one of the methods for presenting the financial data, either cash or accrual basis. Thus, the way your business’s financial statements appear is because of the accounting method used in preparing them. But, mostly the business owners ain’t in knowledge about the method used in preparing the financial statements. As a business owner, you must have knowledge of the accounting method used in the preparation of the financial statements.
However, the consequences of selecting cash or accrual basis accounting can have a strong positive as well as negative implications. Thus, the selection of the most appropriate accounting method is a very crucial concern.
Basis of Accounting
In a general scenario, when you set up a bookkeeping software for your business, you need to select the accounting basis either cash or accrual and consequently the software will automatically work according to the respective accounting method you have opted.
For example, You made a sale on 20th August and you created an invoice with a due date of 10th October. Now, if your accounting software records the revenue instantly when the invoice was generated, it means your business follows the accrual basis of accounting. On the contrary, if you record the revenue in the books of accounts when you actually receive it, it means your business follows the cash basis accounting.
Below is the diagram that presents a clear picture of the difference between both the bases.
Cash Basis of Accounting
Well, cash basis accounting is the most commonly used method of accounting in small scale businesses. Also, they file their Goods and Services Tax(GST) returns and prepare financial statements using the cash accounting method.
Revenue/Income is recorded when received
In the cash basis of accounting, the revenue or income generated is recorded only when the payment is actually received from the debtor. However, this can be a favorable thing for a business, as in case the payment is not received, there would be no prior entry as in cash basis accounting, only the actual receiving of cash is recorded, and therefore, no alterations will be required in the books thereof.
Expense is recorded when it’s actually paid
As the income is recorded only when it is actually received; in the same way, in cash accounting, the expenses are recorded in the books only when they’re actually paid. For example, your outlet’s rent is due for the month of August, and you haven’t paid it yet. Moreover, you pay the due rent for the month of August along with the rent of September. So, now in cash accounting, the rent expense will not be recorded for August, rather it will be recorded for September as the actual payment of expense is done in September.
Accrual Basis of Accounting
The accrual basis of accounting is usually used in large scale business organizations. However, small-scale business units can also use this method too. Let’s understand it in more detail:
Revenue/Income is recorded when the invoice is generated
In the accrual basis of accounting, the revenue/income isn’t recorded when it is actually received as in the case of cash basis accounting. Rather, the income/revenue is recorded as and when the invoice is generated. Let’s get back to that example where the sale was made and the invoice was generated thereon; so if the business follows the accrual method, then it will record the transaction the moment when the invoice is created.
Expense is recorded when the bill is generated
Similarly, the expense will be recorded in the books of accounts when it gets due and not when you actually pay it. Let’s understand with that example, where the rent expense was recorded in the books of accounts when it was actually paid. If the business follows the accrual basis of accounting, the rent expense will be recorded in the books as and when it gets due; it doesn’t matter if the expense has been paid or not, it will be recorded in the books anyway.
However, there are several merits/demerits of both types of accounting methods. The accounting method you choose for your business depends on the type of business you run. So, make your decision wisely analyzing all the factors. Stay connected for more interesting articles. Feel free to share your feedback.
