1.

Cash Basis of Accounting

Transactions are recorded in the books of accounton cash being received or paid.
Cash basis of accounting is a system in which transactions are recorded when cash
is transacted, whether received or paid. It means, revenue is recognised on receipt
of cash. Likewise, expenses are recorded as incurred when they have been paid. The
difference between the total incomes and total expenses represents Profit or Loss of a
business for the accounting period. Thus, when Cash Basis of Accounting is followed,
outstanding and prepaid expenses and income received in advance or accrued incomes
are not considered. Receipts and Payments Account prepared in case of Not-for-Profit
Organisations, such as charitable institutions, clubs and schools, is an example of
accounting on cash basis.
Outstanding Expenses are those expenses which have become due during the accounting period
but which have not yet been paid.
Prepaid Expenses are those expenses which have been paid in advance.
Accrued Income is an income which has been earned during the accounting period but has not
yet become due and, therefore, has not been received.
Income Received in Advance is an income which has been received before it has been earned,
i.e.,goods to be sold or services to be rendered in future.
Advantages
Advantages of Cash Basis of Accounting are:
() Itisa simple basis of accounting as adjustments for outstanding expenses, prepaid
expenses, accrued income and income received in advance is not made.
(i) This approach is more objective as very few estimates and judgnents are required.
(ii) This basis of accounting is suitable for those enterprises where most of the
transactions are on cash basis.
Disadvantages
Disadvantages of Cash Basis of Accounting are:
(i) It does not give atrue and fair view of the profit or loss and the financial pOsition
of an enterprise because it ignores outstanding and prepaid expenses and accrued
income and income received in advance.
(ü) It does not follow the Matching Principle of accounting.
(i) This system does not distinguish between capital and revenue items and, as a
result, there is no consistency in the profitsof the two years.
Illustration 1.
During the financial year 2021-22, Ashok had cash sales of 3,90,000 and credit sales
of? 1,60,000. His expenses for the year were 2, 70,000, out of which 80,000 is still to
be paid. Find out Ashok's income for 2021-22 following the Cash Basis of Accounting.
Solution:
Revenues (inflow of cash, i.e., cash sales) 3,90,000
Less: Expenses (outflow of cash) ( 2,70,000 80,000) 1,90,000
Net Income 2,00,000
Note: Credit sales and outstandingexpenses will not be considered under Cash Basis of Accounting.
2. Accrual Basisof Accounting
Transaction is recorded in the books of account when entered,' whether cash is
received/paid or not.
Under Accrual Basis of Accounting, unlike under Cash Basis of Accounting, income is
recorded as incomne when it is earned or accrued. For example, credit sale is recognised
as sale irrespective of the fact whether amount has been received or not. Similarly, if an
expense has been incurred but payment has not been made, it will be recorded as an
expense. For example, rent for the month of March, 2022 has not been paid. It will still
be recorded as an expense because it had become due.
Accrual Basis of Accounting is based on the concept of realisation and expiration and
follows two basic accounting principles, i.e., Revenue Recognition Principle and Matching
Principle. Thus, under the Accrual Basis of Accounting, outstanding and prepaid
expenses are adjusted. Similarly, accrued income and inconme received in advance are
recognised for ascertaining correct profit or loss for the accounting period.
It maybe noted that the Companies Act, 2013 requires companies to follow accrual
basis of accounting in maintaining the books of account.
Advantages
The advantages of Accrual Basis of Accounting are:
() It is more scientific compared to Cash Basis of Accounting and hence is preferred
by accountants.
(i) This basis of accounting showsa complete pictureof financial transactionsof the
business as it takes intoaccount the effect of all transactions relating to a period
as well as adjustments like outstanding expenses, prepaid expenses, accrued
income and income received in advance.
 (ii) This basis discloses correct profit or loss for a particular period and also exhibits
true financial position of the business on a particular day.
(iv) It reflects true profit or loss during the accounting period and, therefore, has wide
acceptability.
(v) It reflects true financial position at the end of the accounting period by adjusting
outstanding expenses, prepaid expenses, accrued income and income received
advance, etc.
Disadvantages
The disadvantages of Accrual Basis of Accounting are:
(i) This system is not as simple as Cash Basis of Accounting.
(ii) The accounting process is too elaborate.
(i) Aquick appraisal of the profit/loss is not possible because many adjustments are
required to ascertain the true financial position of the business.
Illustration 2.
Taking the figures in Illustration 1, find out the net income according to Accrual Basis
of Accounting.
Solution:
Total Sales = Cash Sales ( 3,90,000) + Credit Sales 1,60,000) 5,50,000
Less: T'otal Expenses for the Year 2,70,000
Net Income 2,80,000

Note: 80,000expenses still to be paid belong tothis year and hence are to be charged to the revenue of thisyear.
Similarly, credit sales of 1,60,000 are taken in the year in which sales transaction is done.
Illustration 3.
Michael gives following information about his income and expenses for the year ended
31st March, 2022:
1,60,000
Expenses paid
40,000
Expenses paid in advance (included in 1,60,000)
20,000
Expenses not yet paid
Income received
2,40,000
30,000
Income received in advance (included in 2,40,000)
24,000
Income not yet received

Determine his income if he adopts (i) Cash Basis of Accounting, and (iü) AccrualBasis
of Accounting.
Solution:
() If Cash Basis of Accounting is adopted:
Revenue:
Income received (A) 2,40,000

Expenses: 1,60,000
Expenses paid (B)
(A - B) 80,000
Net Income (Profit) as per Cash Basis
(ii) If Accrual Basis of Accounting is adopted:
Revenue:
Income received 2,40,000
Add: Income not yet received 24,000
2,64,000
Less: Income received in advance 30,000
(A) 2,34,000
Expenses:
Expenses paid 1,60,000
Add: Expenses not yet paid 20,000
1,80,000
Less: Expenses paid in advance 40,000
(B) 1,40,000
Net Income (Profit) as per Accrual Basis (A- B) 94,000
Illustration 4.
From the following information, determine the profit earned or loss incurred when
)Cash Basis of Accounting is followed, and when (i) Accrual Basis of Accounting
is followed:

Cash Sales 5,00,000

Credit Sales 2,00,000
Outstanding Salary and Wages 4,000
Insurance Paid in Advance 2,500
Outstanding Electricity Expenses 1,000
Income Received (excludingincome received in advance) 5,000
Income Received in Advance 1,000
Income Earned but not Received 3,000
Cash Purchases 2,75,000
Credit Purchases 1,25,000
Salary and Wages Paid 44,000
Electricity Expenses Paid 11,000
Insurance Expenses Paid (includingprepaid) 10,000
Solution:
() When Cash Basis of Accounting is followed:
Revenue:
Cash Sales 5,00,000
Add: Income received 5,000
Income received in advance 1,000 6,000
(A) 5,06,000
Expenses:
Cash Purchases 2,75,000
Salary and Wages paid 44,000
Electricity Expenses paid 11,000
Insurance Expenses paid 10,000
(B) 3,40,000
Net Income (Profit) as per Cash Basis (A - B) 1,66,000
(ii) When Accrual Basis of Accounting is followed:
Revenue:
Sales (Cash + Credit) 5,00,000 + 2,00,000) 7,00,000
Add: Income earned (Income Received + Income earned but
not received 5,000 + 3,000) 8,000
(A) 7,08,000
Expenses:
Purchases (Cash + Credit) 2,75,000 + 1,25,000) 4.00.000
Salary and Wages (Paid + Outstanding) R 44,000+ B4,000) 48,000
Electricity Expenses (Paid+ Outstanding) 11,000 + 1,000) 12,000
Insurance Expenses (Paid -Prepaid) 10,000 - 2,500) 7.500
(B) 4,67,500
Net Income (Profit) as per Accrual Basis (A - B) 2,40,500

Difference between Accrual Basis of Accounting and Cash Basis of Accounting

Basis Accrual Basis of Accounting Cash Basis of Accounting
Nature of Transactions Both cash and credit transactions are recorded. Cash transactions are recorded.
2. Prepaid/Outstanding Prepaid and outstandingexpenses are accountedin Prepaid and outstanding expenses are
Expenses the Profit &Loss Account. not adjusted. Similary, accrued income
Accrued Income/Income Accrued income and income received in advance and income received in advance are not
Received in Advance are also accounted and shown in the Balance Sheet. adjusted.
3. Profit or Loss Correct profit or loss is ascertained because it records Correct profit or loss is not ascertained
both cash and credit transactions. because it records only cash transactions.
4. Technical Knowledge The Accrual Basis of Accounting requires technical It does not require much of technical
knowledge as many adjustments like prepaid,| knowledge as is required for Accrual Basis
outstanding, capitaland revenue are required to be made. of Accounting.
5. Legal Position Accrual Basis of Accounting is recognised by the Cash Basis of Accountingisnot recognised
Companies Act, 2013. by the Companies Act, 2013.
6. Acceptability Accrual Basis of Accounting is more acceptable in Cash Basis of Accounting is not acceptable
business as it reveals correct income and expense in business as it does not reveal the
besides assets and liabilities. required information.
7. Reliability Accrual Basis of Accounting is more reliable as it Cash Basis of AcCounting is less reliable as
records both cash and credit transactionsand thus, it recards only cash transactions and as a
reveals correct profit or loss besides assets andresult doesnot reveal correct profit or loss
liabilities. and also assets and liabilities.
8. Suitability Accrual Basis of Accounting is suitable for businesses Cash Basis of Accounting is suitatble for Not
as it requires information that is complex. It can be for-Profit Organisations and Professionals
made available by Accrual Basis of Accounting. such as chartered accountants, lawyers,
etc, since they require comparatively less
information.