The Concept Behind the Two Bases
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.
Accrual Basis of Accounting
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).
Cash Basis Accounting
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.
Difference Between Cash Basis and Accrual Basis
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.
FAQs on Accrual Basis vs. Cash Basis of Accounting
1. What is the main difference between the Accrual Basis and Cash Basis of Accounting for a Class 11 student?
The primary difference lies in the timing of recording financial transactions. Under the Cash Basis, revenues and expenses are recorded only when cash is actually received or paid. In contrast, the Accrual Basis records revenues when they are earned and expenses when they are incurred, regardless of when the cash is exchanged. This aligns with the CBSE/NCERT curriculum for the 2025-26 session.
2. What are the two primary methods of accounting?
The two main methods, or bases, of accounting are:
- Cash Basis of Accounting: This method recognises transactions only when cash is received or paid. It is simpler and often used by individuals and very small businesses.
- Accrual Basis of Accounting: This method recognises revenues when earned and expenses when incurred, following key accounting principles. It provides a more accurate view of a company's financial performance and is required for most companies in India.
3. Why is the Accrual Basis of Accounting generally preferred for businesses over the Cash Basis?
The Accrual Basis is preferred because it provides a more realistic and comprehensive picture of a business's financial health for a specific period. By matching revenues with the expenses incurred to earn them (the matching principle), it accurately reflects the company's profitability. The Cash Basis can present a misleading picture, as a large cash payment or receipt can distort the financial performance of a single period.
4. Can you give a simple example of how revenue is recorded under the Accrual Basis vs. the Cash Basis?
Certainly. Imagine a business provides services in March worth ₹10,000 but receives the payment from the client in April.
- Under the Accrual Basis, the ₹10,000 revenue is recorded in March, the month the service was completed and the revenue was 'earned'.
- Under the Cash Basis, the ₹10,000 revenue is recorded in April, the month the cash was actually 'received'.
5. How would an expense be recorded differently under the Cash and Accrual bases? Provide an example.
Let's say a company uses electricity worth ₹5,000 in December but pays the bill in January.
- Under the Accrual Basis, the ₹5,000 expense is recorded in December, the period when the electricity was consumed and the expense was 'incurred'.
- Under the Cash Basis, the ₹5,000 expense is recorded in January, the period when the cash was 'paid'.
6. What is the 'Matching Principle' and why is it fundamental to the Accrual Basis of Accounting?
The Matching Principle is a core accounting concept stating that expenses incurred to generate revenue must be recorded in the same accounting period as that revenue. It is fundamental to the Accrual Basis because it ensures that financial statements, like the Profit and Loss Account, accurately reflect the profitability of a period by correctly matching the costs with the income they helped produce, which is a key objective of financial reporting.
7. For which types of entities is the Cash Basis of Accounting more appropriate?
The Cash Basis of Accounting is generally more suitable for small businesses, sole proprietors, and not-for-profit organisations that do not carry significant inventory or have complex transactions. Professionals like doctors and lawyers may also use it for its simplicity in tracking cash flow. However, as per the Companies Act, 2013, most companies in India are mandatorily required to follow the Accrual Basis.
8. Does using the 'Accrual Basis' mean a company can ignore its cash position?
This is a common misconception. The Accrual Basis does not ignore cash; it simply records transactions based on when they are earned or incurred, not paid. Companies using the Accrual Basis must still prepare a Cash Flow Statement. This crucial financial statement exclusively tracks the inflow and outflow of cash, complementing the accrual-based Income Statement and Balance Sheet to provide a complete and balanced view of financial health.
9. How do 'Outstanding Expenses' and 'Accrued Income' relate to the Accrual Basis of Accounting?
These concepts are direct results of applying the Accrual Basis, as taught in the Class 11 NCERT syllabus:
- Outstanding Expenses: These are expenses incurred during an accounting period but not yet paid (e.g., salaries for March paid in April). They are recorded as an expense in March under the accrual method to match them with the current period's revenue.
- Accrued Income: This is income earned during a period but not yet received in cash (e.g., commission earned in March but received in April). The accrual method requires recording this as income in March because it has been earned.
