Differences Between the Accrual Basis and Cash Basis of Accounting
In accounting, the accrual basis and cash basis are two different methods of recording business transactions. The key difference between both of them is the timing of recording the transactions. You may choose the way that you think will suit your business better. However, if accounting is not your thing, you should get assistance from the accounting firm in Johor Bahru before deciding on the method that you want to use.
If you aggregate the amounts over time, you will see that the results of both accrual basis and cash basis will almost be the same. In short, the accrual basis means that the company should only record the revenue when it earns them and record the expenses when it spends them. On the other hand, if a company uses the cash basis, it is going to record the revenue when it receives cash from the clients and records the expenses when they pay to its employees and suppliers.
There is a difference in timing between the two methods because there is a delay in revenue recognition in the cash basis since the company can only record the revenue when its clients pay them. The same situation may happen to the recognition of expenses too, where it can only recognise the expenses when it pays for them. For you to understand the concept better, here are some examples:
Recognition of revenue
A company sells a machine to a client in May, and its client pays for the invoice in June. If it is using the accrual basis of accounting, it should recognise the sale in May as it issued the invoice in that month. However, if the company uses the cash basis, it should recognise the sale when it receives the payment, which is in June.
Recognition of expense
A company buys a computer in July, and it pays for it in August. If it uses the accrual basis, it should recognise the expense in July since it has received the supplier’s invoice in that month. However, under the cash basis of accounting, the company should recognise the expense in August, which is when it pays for the purchase.
Accounting for transactions through the cash basis of accounting is the easiest as the accountants would not need to make complex accounting transactions, for example, deferrals and accruals (Also see Introduction to Accrued Expenses). As it is easy to use, most business owners that run a small company would prefer using it. Nevertheless, as the timing of receiving and spending cash is relatively random, the reported results can have a big variance between abnormally high and low profits. Also, the individuals who wish to monitor their personal financial status would prefer the cash basis too.
All sizable organisations would choose to use the accrual basis of accounting. There are a few reasons for this to happen, which includes:
- The company can get its financial statements audited if they use the accrual basis to generate those statements.
- The company will be able to match its revenues and expenses in a particular accounting period (Also see Basic Accounting Concept – The Matching Principle) if it is using the accrual basis. This helps the company to know its actual profitability.
However, the accrual basis of accounting is unable to tell the company’s ability in generating cash if it does not include a cash flow statement in its financial statements.