Cash and accrual system

To account your business books, you need to follow the principle as defined by the accounting methods. There are two primary accounting methods – Cash accounting and Accrual accounting that a business a choose and apply. Each method has its own way of accounting and impacts differently on how the business financials are measured.

A method that is right for one type of business, may not be accurate for others. It is important for businesses to know the difference between cash basis accounting and accrual basis of accounting, understand the impact and choose the one that suits your business.

Before we get into the key factors that differentiates cash accounting and accrual accounting, let us understand the fundamentals with examples.

Under the cash accounting method, transactions are recorded only when money changes hands. For example, On 1st June,2020, Max fashions sold garments worth Rs. 1,00,000/-. 40% on cash and remaining on a credit basis. Max fashions maintain accounts using the cash method.

On following the cash-based accounting method, Max fashions would recognize revenue to the extent of Rs. 40,000/- (i.e., 1,00,000*40%) on 1st June. Remaining would be recognised as an when it is received.

Under the accrual-based method of accounting, gross income/expenses are reported when it is earned/occurred, regardless of when the income/expenses are collected/paid.

If the above example is maintained in the accrual accounting method, 1,00,000 will be recognized as revenue on the date of sale. The credit sale of 60,000 will be recognized as accounts receivables and 40,000 as cash.

With this understanding let us discuss the difference between cash and accrual basis accounting.

Difference between cash accounting and accrual accounting

We have listed the key differences of cash accounting and accrual accounting that will help you decide on the accounting method.

There is no right or wrong in choosing a cash or accrual method. Each method works differently and has its own advantages or disadvantages. Businesses need to consider their transactions, operations and choose the one that fits the best.