Difference Between Cash Basis and Accrual Basis of Accounting
Cash basis of accounting is a simple and popular method, especially for beginners and small businesses. It records incomes and expenses only when actual cash is received or paid. Knowing this method is essential for school exams, competitive tests, and understanding business reports in real life.
| Accounting Method | When Revenue/Incomes Recorded | When Expenses Recorded | Common Users |
|---|---|---|---|
| Cash Basis of Accounting | When cash is received | When cash is paid | Small businesses, individuals, certain professionals |
| Accrual Basis of Accounting | When earned (regardless of cash) | When incurred (regardless of cash) | Large businesses, companies, required by law for many organizations |
Definition of Cash Basis of Accounting
The cash basis of accounting is a method where incomes are recorded when cash is actually received, and expenses are recorded only when cash is paid. This approach ignores any outstanding or prepaid items. It is simple and widely used by small entities.
How Does Cash Basis Accounting Work?
In cash basis accounting, all transactions are recorded on the basis of cash movements. If no cash is received or paid, no entry is made, no matter when the transaction was agreed upon. This makes record-keeping direct and easy to understand.
Stepwise Recording Process
- Record income only on cash receipt (not when earned).
- Record expense only on actual payment (not when incurred).
- Ignore credit transactions until cash exchanges hands.
Cash Basis Example
Suppose Akash provides tuition and receives Rs. 3,000 in January for December's classes. In cash basis, income is recorded in January. If he pays rent of Rs. 1,000 in February for January’s use, expense is recorded in February.
| Date | Transaction | Journal Entry (Cash Basis) |
|---|---|---|
| 15 Jan | Received tuition fees | Cash A/c Dr. 3,000 To Tuition Fees A/c 3,000 |
| 5 Feb | Paid rent | Rent A/c Dr. 1,000 To Cash A/c 1,000 |
Cash Basis vs. Accrual Basis of Accounting
Confusion between cash and accrual basis is common in exams. The main difference is in the timing of recording incomes and expenses. Review this table for a quick comparison:
| Aspect | Cash Basis | Accrual Basis |
|---|---|---|
| Income Recording | On cash receipt | When earned, even if cash not received |
| Expense Recording | On actual payment | When incurred, even if unpaid |
| Complexity | Simpler, easy for small firms | More detailed and accurate |
| Suitability | Individuals, small businesses | Large businesses, companies (as per law) |
| Financial Position Accuracy | May be misleading for long-term | Accurately reflects financial position |
Advantages of Cash Basis of Accounting
- Simple and easy to use, even without accounting background
- Suitable for small businesses and professionals
- No need to track outstanding or prepaid amounts
- Good for short-term analysis of actual cash flows
- Lower record-keeping and compliance costs
Disadvantages of Cash Basis of Accounting
- Does not show true profitability (because incomes/expenses can be delayed)
- Not accepted by law for companies or firms (as per Indian Companies Act)
- Ignores credit transactions—may mislead about actual business performance
- Not suitable for large organizations or where financial accuracy is needed
- Financial statements may not reflect all assets and liabilities
When is Cash Basis of Accounting Used?
Cash basis accounting is mainly used by small businesses, professionals (like doctors, tutors, freelancers), and some non-profit organizations. It is relevant for basic reporting, simple businesses, and for school/entrance exam questions on fundamental accountancy methods.
Applications and Real-Life Contexts
- Personal finance such as rent, salary, and allowance tracking
- Freelancers receiving cash payments for services
- Tutors, shopkeepers, and consultants who prefer simple accounting
- Quick cash flow analysis for small business decisions
To deepen your understanding, you can visit Accrual Basis and Cash Basis for a detailed comparison, or see worked solutions at TS Grewal Solutions Class 11. For full context, also read about Meaning and Scope of Accounting.
At Vedantu, we simplify Commerce concepts such as cash basis accounting for board exams, competitive tests, and practical knowledge needed by students and business learners alike.
In summary, cash basis of accounting records only real money movements, making it practical for small entities and beginners. It is exam-relevant, quick to revise, and essential for understanding basic accounting, but has limitations in financial accuracy for larger organizations.
FAQs on Cash Basis of Accounting Explained
1. What is the cash basis of accounting as per the CBSE Class 11 syllabus?
The cash basis of accounting is a simple method of recording financial transactions where revenue is recognised only when cash is actually received, and expenses are recognised only when cash is actually paid. This method ignores credit transactions, such as sales made on credit or expenses incurred but not yet paid.
2. What is the main difference between the cash basis and accrual basis of accounting?
The primary difference lies in the timing of recording revenue and expenses. The cash basis records transactions only when cash moves. In contrast, the accrual basis records revenue when it is earned and expenses when they are incurred, regardless of when the cash is received or paid. Accrual basis follows the matching principle, providing a more accurate view of profitability.
3. Can you provide a simple example of how the cash basis of accounting works?
Certainly. Imagine a tutor provides services in March and sends an invoice for ₹5,000. The student pays this amount in April. Under the cash basis of accounting, this ₹5,000 income would be recorded in April, the month the cash was received, not in March when the service was provided.
4. What are the key advantages of using the cash basis of accounting for a small business?
The main advantages of the cash basis method include:
- Simplicity: It is very easy to understand and maintain, as it does not require complex accounting knowledge.
- Cash Flow Tracking: It gives a clear and direct view of the actual cash available to the business at any given time.
- Cost-Effective: It is less expensive to manage, making it ideal for small businesses, freelancers, and professionals with simple transactions.
5. How are transactions like prepaid expenses or income received in advance treated under the cash basis?
Under the pure cash basis of accounting, adjustments for transactions like prepaid expenses, outstanding expenses, or income received in advance are not made. An expense is recorded fully when it is paid, and income is recorded fully when it is received. This is a key difference from the accrual basis, where such items are adjusted to match the correct accounting period.
6. How is profit or loss calculated using the cash basis of accounting?
To determine the profit or loss for a period under the cash basis, you simply subtract the total cash payments (expenses paid in cash) from the total cash receipts (revenues received in cash) for that period. The formula is: Profit/Loss = Total Cash Receipts − Total Cash Payments.
7. Why is the accrual basis of accounting generally preferred and mandated for companies in India?
The accrual basis is preferred because it presents a more accurate and fair view of a company's financial performance. It matches revenues to the expenses incurred to generate them within the same period. The Companies Act, 2013, mandates the accrual basis for companies to ensure that financial statements are reliable and comparable, which the cash basis cannot guarantee due to its focus only on cash movements.
8. Does a Balance Sheet prepared under the cash basis provide a true picture of a business's financial health?
No, a Balance Sheet prepared using the cash basis is often incomplete and does not show the true financial position. This is because it omits significant items such as Accounts Receivable (money owed by customers) and Accounts Payable (money owed to suppliers). This can give a misleading impression of the business's assets and liabilities.
9. How can the cash basis of accounting potentially distort the reported profitability of a business?
The cash basis can distort profitability because profit is tied to the timing of cash flows, which can be managed. For instance, a business could delay paying its bills to the next financial year to artificially inflate its current year's profit. Similarly, aggressively collecting payments before they are due can make a period seem more profitable than it actually was.
10. What is the 'modified cash basis' of accounting and how does it differ from the pure cash basis?
The modified cash basis is a hybrid accounting method that combines features of both cash and accrual systems. While it largely records income and expenses on a cash basis, it incorporates some accrual principles, such as capitalising and depreciating long-term assets. This method offers more accuracy than the pure cash basis while remaining simpler than the full accrual basis.
