Accrual vs Cash Accounting

Module 1:
Foundations of Accounting

Duration:
45-60 minutes

Level:
Beginner to Diploma-Level

➛ Understand the difference between accrual basis and cash basis accounting.

➛ Record revenues and expenses under each method.

➛ Identify when revenue is recognized under the accrual basis.

➛ Explain why accrual accounting is preferred under GAAP/IFRS.

➛ Apply both methods in real-life examples.

➛ Accrual Accounting
➛ Cash Accounting
➛ Revenue Recognition Principle
➛ Matching Principle
➛ Accounts Receivable
➛ Accounts Payable

➛ Record revenue when cash is received
➛ Record expenses when cash is paid
➛ Simple, used by small businesses
➛ No receivables or payables recorded

Example
If a customer buys goods today and pays next month

Revenue recorded next month | when cash is received

➛ Record revenue when earned
➛ Record expenses when incurred
➛ Gives a more accurate financial picture
➛ Required by IFRS/GAAP for most businesses

Example
Customer buys today, pays next month

➛ Revenue recorded today | when earned
➛ Create Accounts Receivable

➛ Shows real performance
➛ Matches income and expenses
➛ Supports financial planning
➛ Used for external reporting

Say if it is Cash or Accrual

➛ Revenue recorded when customer pays
➛ Wages for March recorded even if paid in April
➛ No entry until cash is received
➛ Sale recorded today even if money comes later
➛ Expense recorded because utilities were used

Transaction
Sold services worth $800 on credit.

➛ Earned service revenue $1,000 on credit
➛ Received $1,000 cash from customer later
➛ Electricity bill of $300 received but not paid yet

State whether each fits Cash or Accrual method

➛ Small shop owner prefers simple recording
➛ Listed company preparing financial statements
➛ Requires receivables and payables tracking
➛ Used mainly for tax reporting for micro traders
➛ Better measurement of business performance

A photography company performed services worth $2,500 in December, but customers paid in January.

The business also received an electricity bill of $400 in December but paid in January.

Questions

Under Cash Basis
When will revenue be recorded?
When will expense be recorded?

Under Accrual Basis
When will revenue be recorded?
When will expense be recorded?

Which method reflects December profit more accurately? Why?

➛ Under cash basis, when is revenue recorded?

➛ Under accrual basis, why do we use matching principle?

➛ True or False | Accrual accounting records revenue only when cash is received.

➛ Which method uses receivables and payables?

➛ Which accounting frameworks require accrual accounting?

---

Answers ➧ Here

---

Adjusting Entries | Part 1 ➧ Here