Cash-Basis Accounting Versus Accrual-Basis Accounting

Differentiate the cash basis of accounting from the accrual basis of accounting.

Most companies use accrual-basis accounting. They

◆ recognize revenue when the performance obligation is satisfied
and
◆ expenses in the period incurred,
without regard to the time of receipt or payment of cash.
Cash basis
Under the strict cash-basis, companies financial
statements are
◆ record revenue only when they receive cash, and
not in conformity
◆ record expenses only when they disperse cash. with IFRS.

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 Cash-Basis Accounting Versus Accrual-Basis Accounting

Illustration: Eser Contractor signs an agreement to construct a

garage for ₺22,000. In January, Eser begins construction, incurs
costs of ₺18,000 on credit, and by the end of January delivers a
finished garage to the buyer. In February, Eser collects ₺22,000 cash
from the customer. In March, Eser pays the ₺18,000 due the
creditors.
ILLUSTRATION 3A.1

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 Cash-Basis Accounting Versus Accrual-Basis Accounting

Illustration: Eser Contractor signs an agreement to construct a

garage for ₺22,000. In January, Eser begins construction, incurs
costs of ₺18,000 on credit, and by the end of January delivers a
finished garage to the buyer. In February, Eser collects ₺22,000 cash
from the customer. In March, Eser pays the ₺18,000 due the
creditors.
ILLUSTRATION 3A.2

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 Cash-Basis Accounting Versus Accrual-Basis Accounting

Conversion from Cash to Accrual Basis

Illustration: Dr. L. Liwan, like many small business owners, keeps her
accounting records on a cash basis. In the year 2019, Dr. Liwan
received ₺300,000 from her patients and paid ₺170,000 for operating
expenses, resulting in an excess of cash receipts over disbursements of
₺130,000 (₺300,000 - ₺170,000). At January 1 and December 31, 2019,
she has accounts receivable, unearned service revenue, accrued
liabilities, and prepaid expenses as shown below.
ILLUSTRATION 3A.5

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 Service Revenue Computation
To convert the amount of cash received from patients to service
revenue on an accrual basis, we must consider changes in accounts
receivable and unearned service revenue during the year.
ILLUSTRATION 3A.8

ILLUSTRATION 3A.5
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 Operating Expense Computation
To convert cash paid for operating expenses during the year to
operating expenses on an accrual basis, we must consider changes in
prepaid expenses and accrued liabilities.
ILLUSTRATION 3A.11

ILLUSTRATION 3A.5
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 ILLUSTRATION 3A.12

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 Cash-Basis Accounting Versus Accrual-Basis Accounting

Theoretical Weaknesses of the Cash Basis

◆ Today’s economy is considerably more lubricated by
credit than by cash.
◆ The accrual basis, not the cash basis, recognizes all
aspects of the credit phenomenon.
◆ Investors, creditors, and other decision makers seek
timely information about a company’s future cash flows.

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 CASH BASIS
Income is recognized when received
regardless of when earned, and expense is
recognized when paid regardless of when
incurred.

ACCRUAL BASIS
Income is recognized when earned regardless
of when received, and expense is recognized
when incurred regardless of when paid.

3-9
 Items Cash Basis Accrual Basis
Cash sales plus
Cash sales plus sales
Sales collection of trade
on account.
receivable.
Cash purchases plus
Cash purchases plus
Purchases payment to trade
purchase on account.
creditors.
Items earned are
Items received are
considered as income
Income other than considered as income
regardless of when
Sales regardless of when
received.
earned.
Items incurred are
Items paid are treated
treated as expense
Expense, in General as expense regardless
regardless of when
of when incurred.
paid.
Depreciation is provided Depreciation is provided
Depreciation
normally. normally.
No bad debts are
recorded because trade Doubtful accounts are
Bad Debts
receivables are not treated as bad debts.
3-10 recognized.
 Computation for Purchases
Cash purchases xxx
Purchases on account:
Trade accounts and notes payable, end xxx
Payment of trade accounts and notes payable xxx
Purchase return, discounts and allowances xxx
Total xxx
Less: trade accounts and notes payable, beg. xxx xxx
Total purchases – accrual basis xxx

3-11
 Income other than sales
Income received – cash basis xxx
Add: Deferred income- beg. xxx
Accrued income- end xxx
Total xxx
Less: Deferred income- end xxx
Accrued income- beg. xxx xxx
Income for the current year - accrual basis xxx

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 Expense, in general
Expense paid – cash basis xxx
Add: Prepaid expenses- beg. xxx
Accrued expenses- end xxx
Total xxx
Less: Prepaid expenses- end xxx
Accrued expenses- beg. xxx xxx
Expenses – accrual basis xxx

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 Cash basis + or – Adjustment Required = Accrual basis

Cash paid for wages+ wages payable end-Wages payable beg=wages expense

Cash paid for purchases + AP end- AP beg=net purchases

Cash paid for purchases + AP end- AP beg +Invty beg-Invty end=COGS

Cash receipts from customer+ AR end –AR beg=Net Sales

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The difference between cash and accrual

The difference between cash and accrual accounting lies in the timing of
when sales and purchases are recorded in your accounts. Cash accounting
recognizes revenue and expenses only when money changes hands, but
accrual accounting recognizes revenue when it’s earned, and expenses when
they’re billed (but not paid).
Cash basis accounting

• The cash basis of accounting recognizes revenues when cash is received,

and expenses when they are paid. This method does not
recognize accounts receivable or accounts payable.

• Many small businesses opt to use the cash basis of accounting because it is
simple to maintain. It’s easy to determine when a transaction has occurred
(the money is in the bank or out of the bank) and there is no need to track
receivables or payables.

• The cash method is also beneficial in terms of tracking how much cash the
business actually has at any given time; you can look at your bank balance
and understand the exact resources at your disposal.
Accrual basis accounting

• Accrual accounting is a method of accounting where revenues and expenses are

recorded when they are earned, regardless of when the money is actually received
or paid. For example, you would record revenue when a project is complete, rather
than when you get paid. This method is more commonly used than the cash
method.

• The upside is that the accrual basis gives a more realistic idea of income and
expenses during a period of time, therefore providing a long-term picture of the
business that cash accounting can’t provide.

• The downside is that accrual accounting doesn’t provide any awareness of cash
flow; a business can appear to be very profitable while in reality it has empty bank
accounts. Accrual basis accounting without careful monitoring of cash flow can have
potentially devastating consequences.
 Imagine you perform the following transactions in a month of business:

1.Sent out an invoice for $5,000 for a web design project completed this month

2.Received a bill for $1,000 in developer fees for work done this month

3.Paid $75 in fees for a bill you received last month

4.Received $1,000 from a client for a project that was invoiced last month

Using the cash basis method, the profit for this month would be $925

($1,000 in income minus $75 in fees).

Using the accrual method, the profit for this month would be $4,000

($5,000 in income minus $1,000 in developer fees).

.
In 2021 Sales returns with credit memo amounted to 150,000 and purchase returns
50,000. cash receipts from customer after 200,000 discounts totalled 6,000,000
while cash payments to trade creditors amounted to 4000,000. after discounts of
300,000.

1) Gross Sales for 2021 under accrual basis

2) Purchases for 2021 under accrual basis.
 In 2021 Sales returns with credit memo
amounted to 150,000 and purchase returns
50,000. cash receipts from customer after
200,000 discounts totalled 6,000,000 while cash
payments to trade creditors amounted to
4000,000. after discounts of 300,000.

Cash receipts: 6000000

Account receivable end: 1350000

Accounts receivable beg: (1200000)

Adding back sales discount:200,000

Adding back sales returns: 150,000

= 6500,000 (Gross sales)

 In 2021 Sales returns with credit memo
amounted to 150,000 and purchase returns
50,000. cash receipts from customer after
200,000 discounts totalled 6,000,000 while cash
payments to trade creditors amounted to
4000,000. after discounts of 300,000.

Cash payments: 4000000

Account payable end: 1850000

Accounts payable beg: (1500000)

Adding back sales discount:300,000

Adding back purchase returns: 50,000

= 4700,000 (Gross purchases)

FIN! ☺

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