Accrual Basis vs Cash Basis of Accounting: Key Differences & Examples
The accrual basis of accounting is a foundational concept in commerce, helping students and business professionals understand how financial transactions are recorded. Knowing the accrual concept is vital for Class 11 and 12 exams, competitive tests, and practical business accounting.
| Accounting Method | When Transactions Are Recorded | Main Features |
|---|---|---|
| Accrual Basis of Accounting | When income is earned and expenses are incurred, whether or not cash is received/paid | Follows matching principle; provides more accurate financial statements |
| Cash Basis of Accounting | When cash is received or paid | Simple; suitable for small businesses; less accurate |
What Is Accrual Basis of Accounting?
The accrual basis of accounting is an accounting method where financial events are recognized when they occur, not only when cash changes hands. This means revenues are recorded when earned and expenses when incurred, offering a clearer picture of financial health.
Key Principles of Accrual Basis of Accounting
- Revenue is recorded when it is earned, not necessarily received.
- Expenses are recorded when they are incurred, not only when paid.
- The matching principle ensures that income and related expenses appear in the same accounting period.
- This method uses double-entry accounting for accuracy.
- Provides a realistic view of a business’s financial performance.
Accrual Basis vs Cash Basis of Accounting
| Aspect | Accrual Basis | Cash Basis |
|---|---|---|
| Recording timing | When earned/incurred | When cash received/paid |
| Accuracy | More accurate; preferred by companies | Less accurate for performance |
| Principles applied | Matching, periodicity | No matching principle |
| Accounting standards | Required by accounting standards and Indian GAAP | Not recognized for large firms |
| Best for | Medium/large businesses, exams (Class 11, 12, CA Foundation) | Very small businesses |
Example of Accrual Basis of Accounting
Suppose a business sells goods worth ₹10,000 on 28th March but receives payment on 5th April. Under the accrual basis, the sale and income are recorded on 28th March, when the transaction took place, not in April.
Sample Accrual Basis Journal Entry
| Date | Particulars | Debit (₹) | Credit (₹) |
|---|---|---|---|
| 28-Mar | Accounts Receivable To Sales | 10,000 | 10,000 |
This entry records revenue when it is earned. When the cash is received, another entry is made to show receipt from the debtor.
Merits and Demerits of Accrual Basis
- Merits:
- Provides accurate and realistic financial statements.
- Helps match income and expenses for each period.
- Required by accounting standards and financial statements preparation.
- Demerits:
- More complex than cash basis accounting.
- Needs proper knowledge of double-entry system and adjustments.
- Non-cash transactions may not directly reflect liquidity position.
Related Concepts in Accrual Accounting
- Matching Principle: Links expenses and revenues in the same period.
- Periodicity Concept: Ensures regular reporting of results.
- Basis for preparing final accounts, including the Profit and Loss Account and Balance Sheet.
- Mandatory for most businesses under Indian GAAP.
Summary Table: Accrual Basis of Accounting
| Feature | Accrual Basis |
|---|---|
| Income Recognition | When earned |
| Expense Recognition | When incurred |
| Matching Principle | Yes (income & expense match) |
| Required By | Most standards (GAAP/Companies Act) |
| Common Usage | Exam questions, accounting records, business analysis |
In summary, the accrual basis of accounting helps students and professionals accurately present financial results, matching incomes and expenses, and complying with accounting standards. At Vedantu, we make these concepts simpler through real examples and practical explanations. Understanding accrual accounting is essential for exams and smart financial decision-making.
FAQs on Accrual Basis of Accounting Explained for Students
1. What is accrual basis of accounting?
Accrual basis accounting records revenue and expenses when they are earned or incurred, regardless of when cash changes hands. This differs from the cash basis, which only records transactions when cash is received or paid. It provides a more accurate picture of a company's financial performance.
2. Give one example of accrual basis of accounting.
A company performs services in December but receives payment in January. Under the accrual basis, the revenue is recorded in December (when earned), not January (when received). This follows the revenue recognition principle.
3. What is the difference between accrual and cash basis of accounting?
The main difference lies in the timing of revenue and expense recognition. Accrual accounting recognizes transactions when earned or incurred, while cash basis accounting recognizes them only when cash is exchanged. Accrual offers a more complete financial picture but is more complex.
4. Why is the accrual basis of accounting generally preferred?
Accrual basis accounting is generally preferred because it provides a more accurate and complete picture of a company's financial position and performance. It adheres to Generally Accepted Accounting Principles (GAAP) and offers better insights for decision-making, though it's more complex than the cash basis.
5. How is an accrual basis journal entry recorded?
An accrual basis journal entry follows the double-entry bookkeeping system. It involves debiting and crediting accounts to reflect the earned revenue or incurred expenses. For example, recording accounts receivable when services are rendered but not yet paid.
6. What is an example of accruals basis?
An example is a business providing services in March, but receiving payment in April. Under the accrual basis, the revenue is recognised in March (when the service was performed), illustrating the matching principle, aligning revenues with related expenses.
7. What are the differences between cash and accrual basis accounting?
Cash basis records transactions when cash changes hands, while accrual basis records when earned/incurred. Accrual is more accurate but complex; cash is simpler but less comprehensive. This impacts financial statements and tax calculations. A comparison table highlights key differences.
8. What does accrual mean in accounting?
In accounting, accrual refers to the method of recording revenue and expenses when they are earned or incurred, irrespective of the actual cash flow. It's a core principle of accrual basis accounting and contrasts with the cash basis.
9. What is the accrual basis of an accounting record?
The accrual basis of accounting records revenue when earned and expenses when incurred, regardless of cash flows. This ensures financial statements reflect the true economic performance of a business, aligning with the matching principle in accounting.
10. How does the accrual basis improve the reliability of financial statements?
Accrual accounting improves the reliability of financial statements by providing a more accurate picture of a company's financial performance. By matching revenues with expenses in the period they occur, it offers a truer reflection of profitability than the cash basis method.
11. Accrual basis of accounting example
A business sells goods on credit in January. Under accrual accounting, the revenue is recorded in January, even though cash payment is received later. This exemplifies the core principle of recognizing revenue when it's earned, not when cash is received.
12. Accrual basis of accounting journal entry
An accrual basis journal entry for revenue involves debiting accounts receivable and crediting revenue. For expenses, it involves debiting the expense account and crediting accounts payable. This maintains the double-entry bookkeeping system.
