Cash vs. Accrual Basis of Accounting

Cash Basis:

Under the cash basis of accounting, financial transactions are recorded as and when cash is received or paid. No entry is passed when a payment or receipt becomes due. Income under the cash basis of accounting, therefore, represents the excess of receipts over payments during an accounting period. This system is mostly used in the government sector, not for profit organizations and small scale businesses.

Accrual Basis:

Under the accrual basis of accounting, the revenue is recognized on the occurrence of the transaction rather than its actual receipt. Similarly, the costs are recognized when they are incurred and not when the payment is made. This assumption makes it necessary to give certain adjustments in the preparation of the income statements regarding revenues and costs.

Application of accrual concept provides more accurate and comparable results over different periods as it takes into account all period-related income and expenses while under cash basis financial results may vary from period to period only due to the variations in Company’s working capital cycle.

Example:

Purchases (On Cash) – $ 10,000
Sales (On cash) – $ 10,000
Sales (On credit) – $ 2,000

Profit and loss statement under both accounting systems would be as follows:

Cash basis of accounting Accrual basis of accounting
Sales 10,000 12,000
Less: Cost of sales 10,000 10,000
Gross Profit 2,000

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