The accounting methods consist of these two – Accrual Basis of Accounting and Cash Basis of Accounting. The accrual part measures the company’s financial performance and position by recognizing the economics events. While, cash accounting is done at the time of payment. This is an accounting method where the payment receipts are recorded during the period when they are actually paid. All revenues and expenses are recorded when the cash is received and paid respectively.
Accrual Method is processed regardless of the fact of occurrence of the cash accounting. Thus, we see the difference in the two processes, their contrast is even more highlighted in the further sections while we first discuss the processes entirely.
In financial words, the meaning of ‘accrual’ is adding together the interest or the different investments over a period of time. This also holds a very specific meaning in the accounting language, where it refers to the account in the balance sheet which represents liabilities and non-cash-based assets which are used in the accrual basis of accounting.
What do we do on the accrual basis of accounting? We simply match the expenses with the revenues. The expenses are recorded right at the time when the title has been transferred rather than at the time when the expenses are actually paid.
In the balance sheet, the effect for the same is visible. When expenses occur, there is a considerable decrease in the cash (if paid immediately) or increase in the accounts payable (if bought in credit) or a decrease in prepaid expenses (if paid earlier).
The other method of accounting is this – Cash Basis of Accounting also known as the cash method of accounting, cash receipts and disbursements method of accounting records. These are recorded when cash is received and when expenses are paid in cash.
In this accounting method the revenues are recognised precisely when the cash is being received or is being paid. This method is completely different from accrual basis of accounting, accrual basis of accounting occurs when the revenues are recognised when they are earned and then the expenses are matched with the accounting period when they are incurred (not while they are paid). This cash basis of accounting is usually followed by the individuals and by the small companies, but this basis of the accounting system does not comply with the accounting matching principle.
We have discussed in a vivid manner the definitions of accrual and cash basis of accounting. We understood that both the bases are required to process two different events in the company. We also know, both these bases are in contrast to each other, hence now we will end the topic by discussing the differences.
The pioneer difference of the two is timing. In the cash basis method, the recording done is more immediate while in the accrual basis of accounting it focuses on the anticipated revenue and expenses.
We will understand the difference more conceptually with both facets – Revenue and Expense Recognition.
How Does Both Respond in Recognizing the Revenue?
A company sells a product to a customer worth Rs.10,000 in the month of August. The customer pays in the month of September.
In Cash Basis – The company recognises the sale only in September when the cash is received from the customer.
In Accrual Basis – The company recognises the sale in August itself when the sale invoice is being issued by the company.
How Does Both Respond in Recognizing the Expenses?
The same company buys office equipment worth Rs. 5000 in the month of March, which it pays in April.
In Cash Basis – The company recognises the purchase in April, when it pays the bill.
In Accrual Basis – The company recognizes the purchase in march itself when it happens.
These were the differences and the definitions about the two bases of accounting.
1. What is Meant by Accounting Methods?
Ans. An accounting method means the rules a company follows while reporting the revenues and the expenses. There are two primary methods of accounting which are - are accrual accounting method used by the companies and cash accounting method used by individuals.
As all businesses are required to keep the accounting records and thus, they need to select a typical method to record their transactions.
2. What are Expenses and Revenues?
Ans. Expenses are those types of expenditure which flows through the income statement. They are deducted from the revenue to come to the net income. These are recognised as expenses when they are incurred in the accrual basis of accounting.
While, revenues are the payments that are received by the company. They are recognised when received actually in the cash basis of accounting.
3. What is Meant by Expenses Incurred?
Ans. An incurred expense is the cost which a business incurs when it purchases goods or services on terms of credit. The purchases can be made either through a credit card. For example, if Company ABC purchases goods worth Rs.1,000 on credit, the company will be liable to pay expense of Rs.1000 which is the incurred expense of Rs.1,000.
4. What is the ‘Matching Principle’ of Accounting?
Ans. The matching principle is the accounting concept which dictates the companies to report the expenses. If the expenses are incurred during a period then it shall be recorded in the same period in which its related revenues are earned.