Cash Basis of Accounting vs Accrual Basis of Accounting

This report discusses the difference between cash basis and accrual basis of accounting, their concept, reason for difference, explanation through examples, pros and cons, and recommendation. It also includes references. The accrual basis of accounting is recommended as it gives the true result of the organization for the given accounting period. Read more on Desklib.

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By student name
Professor
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Date: 07 January 2018.
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Contents
Introduction.................................................................................................................................................3
Analysis........................................................................................................................................................3
Concept of the terms...............................................................................................................................3
Reason for difference..............................................................................................................................3
Explanation through examples................................................................................................................4
Pros and Cons..........................................................................................................................................4
Conclusion and Recommendation...............................................................................................................5
References...................................................................................................................................................6
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Introduction
The given report discusses on one of the major topics of accounting and finance which forms the
basis of accounting and preparation of the financial statements of the entity. The topic is Cash
basis of accounting vs the accrual basis of accounting. Whenever the initial recognition of the
entry is being done in the books of accounts or the journal entry is being passed, then the first
thing which is determined is whether it pertains to the given period or not irrespective of
whwther the cash has been received or not (Alexander, 2016). These are 2 methods of recording
the transactions but underlying difference is timing of recording the transaction. When the results
of these 2 methods are aggregared, the results would fairly be the same.
Analysis
Concept of the terms
A brief description of the 2 terms is given below:
Cash Basis: Revenue or sales is being recorded when the cash or the amount is received in bank
from the customer and the expenses or costs are being booked when the cash is being paid to the
suppliers of the goods or the creditors for expenses (Bromwich & Scapens, 2016).
Accrual basis: Revenue or the sales is being recorded only when it is earned and the costs and
expenses is being recorded only when the same is consumed.
Reason for difference
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The reason for the timing difference is that the revenue recognition under the cash basis is being
delayed until the cash payment made by the customer reaches the company. On the other hand,
the recognition of the expenses in the books is delayed until the payment is made to the supplier
for his bills or invoices (Choy, 2018).
Explanation through examples
The concept can be best explained with the help of examples shown below:
Revenue Recognition: A company sells some machinery to one of the customer worth $ 10000 in
April for which the invoice was also sent in April but the payment was made by the customer in
May. Now, under the cash basis of accounting, the company will be recognising the revenue in
the books in the month of May when the payment is being received whereas under the accrual
system, the revenue will be recignised in the month of April when the invoice was being issued
(Fay & Negangard, 2017).
Exepense Recognition: Just like the above case, suppose the company buys the goods for $ 6000
in June and the same is being paid for in the month of July. Then, under the cash basis of
accounting, the expenses will be recognised in the month of July whereas under the accrual basis
of accounting, the same will be recognised a expenses in the month of June itself when the
invoice from supplier was received.
Pros and Cons
Cash basis of accounting is easiest to follow as there is no complexity in accounting involved for
recording of accruals and deferrals but the same is ideal only for the small businesses otherwise
the results of the business would be giving a wrong picture as the timing of cash receipts and
payments may be random and erratic not following any particular pattern (Vieira, O’Dwyer, &
Schneider, 2017). On the other hand, accrual basis is being used by large corporation because of
a variety of reason. It ensures linearity in booking of expenses and incomes in the books in case
the same is monthly or quarterly or annual in nature. Under accrual system, it will be recorded
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irrespective of receipt and therefore help in giving the correct business results. The company’s
accounts can only be audited if it has been prepared under accrual system and the computation of
tax also requires the cash system to be followed (Dumay & Baard, 2017).
Conclusion and Recommendation
The accrual basis of accounting is recommended as it gives the true result of the organization for
the given accounting period. It also satisfies the qualitative characteristics of the accounting and
accounting standard as it satisfies the matching principle and the accrual basis. Futhermore, it
also gives the unbiased picture of the results of the businesses and gives linearity to the recording
of transaction. Most of the companies, more than 99% is following the accrual basis of
accounting so that the users of the financial statements get the true and fari view of the state of
accounts. Though it is better in terms of analysis and presentation but it tends to obscure the view
of cash flow requirement of the business and hence the cash flow statement is also being
prepared by the businesses to analyse that aspect.
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References
Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-
431.
Bromwich, M., & Scapens, R. (2016). Management Accounting Research: 25 years on. Management
Accounting Research, 31, 1-9. Retrieved from https://doi.org/10.1016/j.mar.2016.03.002
Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview
Analysis. Ecological Economics, 145. Retrieved from
https://doi.org/10.1016/j.ecolecon.2017.08.005
Dumay, J., & Baard, V. (2017). An introduction to interventionist research in accounting. The Routledge
Companion to Qualitative Accounting Research Methods, 265. Retrieved from
https://books.google.co.in/books?
hl=en&lr=&id=PzQlDwAAQBAJ&oi=fnd&pg=PA265&dq=Dumay,+J.,+%26+Baard,+V.+(2017).
+An+introduction+to+interventionist+research+in+accounting.
+The+Routledge+Companion+to+Qualitative+Accounting+Research+Methods,
+265.&ots=ta1isTHB
Fay, R., & Negangard, E. (2017). Manual journal entry testing : Data analytics and the risk of fraud.
Journal of Accounting Education, 38, 37-49.
Vieira, R., O’Dwyer, B., & Schneider, R. (2017). Aligning Strategy and Performance Management Systems.
SAGE Journals, 30(1).
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