There are two primary methods of accounting, cash basis accounting method and accrual basis accounting method. The main difference between the two is the timing and both methods are approved accounting methods. However, it depends on an organization as to how it maintains it books using either method. Let's take a little deeper look at what makes them different from each other.
The cash basis accounting method involves reporting income when it is received and expenses, when they are paid, whereas, in accordance with accrual basis accounting method, the income is reported when it is earned and expenses when they are incurred. Although both accounting methods are useful as per the situations demand, the accrual basis accounting method is most commonly used in business organizations.
The reason that why accrual basis accounting method is most useful, because it provides the results of operations accurately. For example, when a business makes sales or provides services on credit basis to the customers, the financial entry that needs to be generated or made is debiting receivables and crediting revenues. So, providing required information in terms of revenues and receivables, the results are matched in an accurate manner. Conversely, cash basis accounting method does not provide such system for maintaining unpaid bills, as it is used when the income is received in cash. This way, accrual basis accounting makes a reasonable basis to track receivables being established for the customers who owe to organization.
The accrual basis accounting method is widely used, as it enables to track income and expenses.
It is through the accrual method of accounting that revenues and expenses are matched within the time frame when the revenues are earned and the expenses are incurred. Facilitating to make careful estimates against revenues that are recorded, but are not received, it helps to establish bad debts. It thus aims at providing more meaningful financial information.
There are situations when a business organization needs to maintain liabilities in terms of salaries, vacation pay or other expenses. The same principle, that is, reporting expenses when they are incurred, need be followed. This involves debiting expenses and crediting liabilities and leads to prepare various schedules which in turn serves the purpose of matching and tracking the results accurately.
Though the accrual accounting method requires adjustments, such as, unearned revenues, and prepaid expenses, at the end of the period, yet it is most useful in a business to maintain exact and accurate financial information in a timely manner. It must be noted that accrual basis of accounting provides the complete historical record of financial information which in turn can facilitate in many ways including making the reports of trend analysis.
K. A. Fareed (Fareed Siddiqui)
Writer, Trainer, Author, Software Developer
BBA, MBA-Finance, MPhil-Financial Management, (PhD-Management)
Module 1 - Leadership and Management ILM – UK
Individual Member of Institute of Management Consultants of India
Income statement is one of the five (as per U.S. GAAP) main financial statements, the other four financial statements are: Balance Sheet, Statement of Cash Flows, Statement of Comprehensive Income and Statement of Changes in Stockholder’s Equity..
Accounting has become one of the essential part of our daily lives. All of us try to generate our own ideas in order to make money related plans.
The process of Financial Accounting entails some essential functions. One of the main functions of financial accounting is recording.