Question

The practice of reporting financial information as a function in today’s operation of a medical practice is particularly important due to intense demands for fiscal acuity. Therefore, it's important to understand the difference between cash and accrual accounting.
What is the difference between cash-basis accounting and accrual accounting?

Why select one and not the other? How does each method affect the financial statements?

Answer 1

Difference between cash-basis accounting and accrual accounting

Recognising actual inflow and outflow of cash in books of accounts is called cash basis accounting. This is a simple form of accounting. Companies act does not recognise this method. There is no concept of matching cash inflow to outflow in this method. The degree of accuracy in this method is considered to be low.

This method recognises income / expense on a merchantile basis. This is relatively complex method of accounting. The income statement may show a higher income in this case.There is matching concept applicable in this method of accounting. The Companies act recognises this method as a valid form of maintaining books of accounts. The degree of accuracy is comparatively high.

Selecting one over the other

Cash basis accounting method is not recognised under the companies act. The degree of accuracy is low. The income in the income statement is usually understated. There is no matching concept, thereby does not give an idea of which prodcucts / service lines are profitable and which ones are not.

Accural method is a recognised form of book keeping. It is considered accurate. The income in the income statement may be higher. The matching concept enables isolation of projects and assessement of profitability of the particular product / service line.

Hence, Accrual method should be selected over cash basis.

Effect on financial statements

The income in income statement in cash basis will be lower compared to income recognised in accrual accounting method.

The balance sheet in the case of cash basis will not have creditors in the liabilities side and debtors on the asset side. In accrual method, creditors and debtors will be stated in the balance sheet on liabilites and asset side respectively.