The cash basis of accounting recognizes revenue and expenses at the time of actual receipt or payment of cash. The cash basis of accounting is less accurate than the accrual basis of accounting as they affect the company’s books only when a complete exchange of value has occurred. Cash basis of accounting might be easier and cheaper to maintain but the needs of users of financial statements are not satisfied due to the inaccurate nature of this method.
According to the accrual concept, revenue and cost are recognized as and when they occur instead of when they are actually paid or received in cash. The revenue is generated and the costs are incurred when the legal right to receive or obligation to pay is established.
Difference between Cash Basis and Accrual Basis of Accounting
|Basis of difference||Accrual Basis||Cash Basis|
|Preferred by||Businesses involving both cash and credit transactions.||Businesses involving predominantly cash transactions.|
|Reliability||As this method involves the preparation of all accounts, it is comparatively much more reliable as it helps us ascertain|
|This method involves the preparation of only cash account and personal accounts, thus it is not a reliable basis for the preparation of accounts. It does not lead us to correct profit.|
|Users||A profit-oriented business enterprise usually prepares its accounts on an accrual basis.||Professionals like Doctors, Lawyers, etc, small ventures of temporary nature, some non-trading enterprises or institutions with service motives usually follow this method.|
|Adjustments||This method involves adjustment of accounts for preparation of financial statements||It is a simple method as it does not involve many adjustments.|
International Financial Reporting Standards (IFRS)
International Financial Reporting Standards are designed to serve as a common global language of business affairs so that accounts of various companies are understandable and comparable across international boundaries.