Meaning of Basis of Accounting
The Basis of Accounting is related to the timing of recording the business transaction in the books of account. It is concerned with a specific time period at which all the incomes and expenses are recorded by a business enterprise. There are two bases for recording the transactions in Accountancy:
- Cash Basis
- Accrual Basis
1. Cash Basis of Accounting
The cash basis records only cash transactions, i.e., all the expenses paid in cash and all the revenues that have been received in cash. No credit transactions are recorded in cash basis accounting system. This means that there are no records of income receivables and expenses payable. Thus, the profit on a cash basis is the difference between the cash receipt and the cash payments. Moreover, taxes on income are paid on the receipt of cash and not when the income is accrued. The cash basis of accounting is suitable for the professionals such as lawyers, doctors, etc.
Example: Rent for April 2022 is payable on 31st December 2022.
On a cash basis, this transaction shall be recorded on 31st December 2022 in an event of actual cash payment, i.e., rent shall be treated as an expense for the period when it is paid.
2. Accrual Basis of Accounting
The accrual basis records all business transactions, whether cash or credit transactions. This means incomes are recorded as soon as they are accrued, irrespective of the fact whether cash is received or not. Similarly, expenses are recorded when they become due even though not yet been paid. This basis takes into consideration all the outstanding expenses and accrued revenues. Thus, profit under this basis is the difference between all the income earned (received in cash or not) and all the expenses incurred (paid in cash or not) during the period. Taxes on income gets due as soon as income is earned. The accrual basis is suitable for all the business units working with an objective to earn profit.
Example: Commission accrued in January 2022, receivable in July 2022.
On an accrual basis, a commission is recorded as an income for the period of January, i.e., as soon as it is earned.
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