Question

Explain the difference between the cash-basis of accounting and the accrual-basis of accounting. Are adjusting entries necessary in both methods? Explain.

Answer 1

Difference between cash basis of accounting and the accural basis of accounting.

1. Cash basis and accural basis are 2 different method of recording accounts transaction. The main difference between the 2 methods is the timing of recording the transaction when revenue and expenses are recognized.

2. Under cash basis method revenue is recorded on the income statement when cash is received and expenses are recorded only when cash is paid out where as in accrual method revenue is accounted when it is earned and expenses are recorded even when no cash being paid out for those expenses.

3. Example of accrual and cash methods: Let's assume you sell the equipment for $1000, under the cash method amount is not recorded until you receive the money from the buyer. However, in accrual method, the $1000 recorded immediately as revenue even you recieve the money after some days or weeks.

Yes, adjusting entries are necessary in both the methods however, it has advantages and disadvantages as well. For example Adjusting entries in accrual based method are periodic requirement. Its advantage is that it keeps the book account in proper order and make sure it matches the revenues and costs which is earned and incurred. Disadvantage is that it requires lot of additional work as several adjusting entries needs to be given at the end of each period.