It’s important to understand the basic difference between the cash basis accounting method and the accrual method.
Append below, in tabulated form, the characteristic of both methods and some salient points to understand the importance of the different methods.
|
CASH ACCOUNTING METHOD |
|
1. All financial transactions events are based on cash basis. This applies to all incoming receipts or outgoing payments or outflows of an enterprise. |
|
2. Based on this accounting method, revenue of the enterprise is not been properly taken up nor expenses in relation to earning the revenue are accounted for. In other words, we can say that Cash-basis accounting does not recognize promises to pay or expectations to receive money or service in the future, such as payables, receivables, and prepaid expenses |
|
3. Normally, cash basis accounting applies to very small concern where the recording of transaction are simple and does not need to conform to any generally acceptable accounting principles. Also, cash basis accounting applies when the accounting process is very short for example, the supplier invoices needs to be paid very early or billings and collections involves a very short span of time. |
|
ACCRUAL ACCOUNTING METHOD |
|
1. Unlike the cash basis accounting method, accrual method is based on the matching and prudence concept. It also consider the proper way of recognizing revenue. |
|
2. Without this accrual accounting method, the entity is not able to reflect the true obligations to its suppliers or the correct amount owing by its customers. |
|
3. Normally, accrual accounting is practiced during the accounting close so as to take up all expenses and revenue not yet taken in the books of accounts. This normally form part of the accounting routine of the accounting month end adjustments. |
|
SALIENT POINTS TO NOTE |
|
1. Some sole proprietors practice cash basis accounting with the intention to reduce their profit so as to deceive the Inland Revenue. By doing cash basis, both revenue and profit before tax will be understated. If “modified†cash method for taking up the cash outflow namely taking up the bills from suppliers and instead of basing on cash payment basis so as to increase the expenses incurred, this will further understate the profit. Hence, taxes payable will then be lower. |
|
2. On the contrary, Inland Revenue will require enterprise to prepare their financial statement based on an accrual accounting basis so that both revenues and expenses are properly stated and profit is more accurate. |
|
3. Needless to say, as cash basis accounting does not conform to generally acceptable accounting practice (GAAP), this methodology is not acceptable amongst Certified Accountants Associations |