Bases of accounting refers to the plan under which revenues and expenses. So, they are recognize in the financial statements of a business. Moreover, a business validity revenue when earns and expenses when expenditures is consume.
The most significant function of accounting is to determine profit earn or loss. Therefore it suffer by a business during an accounting period.
Type of Bases of Accounting
- Cash Basis of Accounts: An accounts method where in revenues are recognize when cash is receive and expenses are recognize when pays. This method is status to the accrual bases of accounts where revenues are recognize. Therefore, they earn and expenses are match to revenues or the accounting period when they are suffer. So, the cash bases of accounts is usually follow by individuals and small companies. But it is not in compliance with accounting’s matching principle.
- Accrual Basis of Accounts: Accrual basis is a method of recording accounting transactions for revenue when earns and expenses when suffer. Likewise a key advantage of the accrual basis is that it matches revenues with related expenses. So, that the complete impact of a business transaction can seen with in a single reporting period.
Advantage and Disadvantage of Cash Bases
- Since it is a single-entry system and simple it is easily understand by people with very less or no knowledge and background in finance and accounting.
- No train bookkeeper or accountant is require to implement and maintain this system.
- It does not require complex accounting software. Subsequently a business can undoubtedly keep up a money premise single-passage framework in a note pad or on a straightforward spreadsheet.
- Since it tracks cash inflow and outflow, a firm knows how much actual cash it has at a given period.
- Businesses can accelerate payments to reduce their taxable profits, thereby deferring tax liability.
- Some lenders may require the accounts preparation as per the GAAP (Generally Accepted Accounting Principles) provisions and hence, would refuse to lend money.
- If the company wants to approve Audited Financial Statements, the accounts prepared under the cash basis of accounting are not consider.
- If one switches every year from accrual to cash basis accounting and vice versa, there will be a lot of burden on the administrator. Therefore in the accrual accounting, income recognition is on the occurrence and not on its receipt. So, again this will increase the profits in one year, hence not showing accurate profits.
- The Companies Act doesn’t consider this system.
There is no requirement to maintain the books of the assets and liabilities. So, if one doesn’t take care of their assets, they might get misplace or stolen.
- There are chances of discrepancies as one can show more expenses and less income involving unfair trade practices.
Advantage and Disadvantage of Accrual Bases
- It gives a precise picture of generally speaking income for the business. Numerous business exchanges happen over a time of a while and along these lines a few bookkeeping periods. Gathering bookkeeping mirrors that salary and costs produced in one month can persist into the following month or much more.
- Financial specialists lean toward collection bookkeeping. A business that utilizations collection bookkeeping is frequently taken a gander at as more lasting and built up than organizations that utilization money premise bookkeeping techniques.
- It’s the favored technique for GAAP. The Generally Accepted Accounting Principles set out by the Financial Accounting Standards Board lean towards collection bookkeeping over money premise bookkeeping on the grounds that the budget summaries for a business that utilizations accumulation bookkeeping are considered increasingly exact since the exchanges reflect when they really occurred rather than when cash is trade.
- Quite complex: is anything but difficult to record and simple to keep up. But accrual accounting is very difficult to record since every time a financial transaction happens, there should be an entry in the books of accounts. And maintaining the whole accounting system isn’t an easy job as well.
- Holistic but difficult to maintain: A business has different aspects. And if a business is huge, in a single day hundreds and thousands of financial transactions need to be record under accrual accounting. So, maintaining all of these every day, day after day isn’t an easy job for any accountant.