Question

Explain two key principles which are the foundation of accrual basis of accounting. provide an example of how accrual and cash basis differ

Answer 1

A business that uses the accrual basis of accounting recognizes revenue and expenses in the accounting period in which they are earned or incurred, regardless of when payment occurs. This differs from the cash basis of accounting, under which a business recognizes revenue and expenses only when cash is received or paid. Two concepts, or principles, that the accrual basis of accounting uses are the revenue recognition principle and the matching principle.

Revenue Recognition Principle: Revenue is the money a business generates by selling products and services to customers. The revenue recognition principle states that a business must recognize revenue in its records in the period in which a sale occurs, even though the business may collect payment from the customer in a different period. The result is that a company’s reported revenue for a particular period typically differs from the cash it collects from customers during that period.

Matching Principle: Expenses are costs that a business incurs to generate revenue. The matching principle states that a business must record the expenses it incurs in the same accounting period as the revenue to which those expenses contribute, even though a business may pay for those expenses in a different accounting period. The result is that a company’s reported expenses typically differ from the amount of cash it paid for expenses in a particular period.

Example for Cash Verses Accrual Basis of Accounting:

Let us assume a Credit Sale of $ 1Million, If accrual Basis is followed, Accounting Entry will be passed by Crediting Sales Account and Debiting Trade Debtors(Customer's) ccount.

Whereas in case of Cash System of Accountin is followed, As cash is not yet Recieved, No Accounting will be done for the given transaction.