Cash basis vs. Accrual basis accounting

The main objective of accounting is to ascertain the profit or loss of a business enterprise at the end of an accounting period.

There are two basis of Accounting-

• Cash Basis of Accounting
• Accrual Basis of Accounting

Under this, the income & expenses are booked on cash basis i.e. incomes are recorded on receipt basis or expenses are recorded on payment basis, other than cash i.e. credit transactions are not recorded in their books. This type of accounting is mainly useful for professionals like Doctor, Lawyers & Chartered Accountants etc.

Advantages-

• This is simple, realistic and satisfies the conservative instinct of many people.
• It is suitable for those enterprises where most of the transactions are on cash basis.
• It does not require the use of estimates and personal judgments.

Disadvantages-

• It does not give a true and fair view of profit & loss and financial position of the enterprises because other income/expenses like outstanding expenses, prepaid expenses, accrued incomes and incomes received in advance.
• Companies Act, 2013 does not recognize it.
• It does not follow matching principle of accounting. For example, acquisition of fixed assets will have to be treated as expenses of the period in which payment is made instead of the periods in which benefits are derived from them.
• Since capital and revenue items are not distinguished in cash basis, there is not consistency in the profits of different years.
• Credit sales/ purchases also not considered in sales or purchase of the enterprises because only cash sales/purchases are booked. It does not provide the clear pictures of their financial strength.

Under this, incomes are recorded when they are earned or accrued, irrespective of the fact whether cash is received or not, example sales/ purchases made on credit will be including in total sales/ purchases. Expenses like rent due to the landlord but not paid will be treated as expense for the period. All expenses/incomes are booked on accrual basis. It is necessary to consider outstanding expenses, prepaid expense, accrued incomes or incomes received in advance etc. for preparation of financial statement. As per Companies Act 2013, all companies are required to maintain their accounts according to accrual basis of accounting.

Advantages-

• It discloses true profit or loss for a particular period and also depicts true financial position of the business at the end of a particular period because it takes into accountant all transactions relating to a particular period and takes into account all adjustment like outstanding expenses, prepaid expenses, accrued income and income received in advance.
• It follows the matching principle of accounting.
• It is recognized by Companies Act 2013
• There is consistency in the computation of profits of different years in accrual basis because it makes a distinction between capital and revenue expenditure.

Disadvantages-

• It is not simple as cash basis of accounting.
• It requires the use of estimates and personal judgments.

Distinction between Cash Basis of Accounting and Accrual Basis of Accounting