There are two based types of accounting measurement to determine the profit. They are cash basis and accrual basis. Business can use either a cash basis or accrual basis to work there profit. However, most of the company prefers to use accrual basis instead of others. In this essay, I will compare the difference between cash basis and accrual basis on expense and revenue. In addition, how can company choose their measurement of profit will also be discussed. Cash basis & accrual basis
Cash basis accounting is focus on cash flow, the companies record the revenue and expense when the cash flow really comes into their account. In other words, revenue is record when cash is received and expense record when cash is paid. (Bushman 2007) cash basis does not record payment or cash received on credit. As a result, it has fewer journals than accrual basis accounting like sale journal, purchase journal. Small companies also prefer this record method; however, it has both advantages and disadvantages. For the advantages, cash basis accounting is easier and cheaper to manage and record.
If your business is only a small company or the major sale is based on cash, and you don not maintain any inventory. The cash basis accounting will suit for you and reduce you expense on record-keeping. In addition, if a company sells their stock on credit, the cash did not come into their account, but they have already sold their stock and received income from it. The income is not subject to taxation until the money actually received. (Wiley 2006) or the disadvantages, cash basis accounting can not match the expense and revenue to the accurate ones.
For example, if you sell some thing on credit but did nor receive the money in this financial year, this revenue will not be record to the account and this lead to a mistake in your profit account. Accrual basis accounting means income recognized when the anticipated inflow of economic benefit cab be reliably measured and expense recognized when the consumption of benefits can be reliably measured. ( Hoggett,2009 P130) For example, when a customer purchase our stock on credit, the income from the stock will be record to our account immediately.
The same with income, our purchase expense on credit will be put into the account as it actually occurs. Accrual basis accounting is choosing by most of the companies because of its advantages. When there is an expense has been record into the account before cash has been paid, it will be record into an accrued account first. It is just like an account payable. (Bushman 2007) As a result, the expense or revenue will be record as it occurs instead the cash come into account. The account will be more accurate to the current profit statement of the company.
For the disadvantage, the accrual basis accounting is more complicated than the cash basis accounting. Companies need more money and resources to train their staffs. Another disadvantage is that company need to pay their tax before the cash really come into their account. However, according to the information above, accrual basis accounting is more accurate for company to measure their profit. Income & expense in this two methods Income represents increase in economic benefit like an increase of asset or a decrease of liability. Revenue is regard as a major part of income.
In the cash basis accounting, the income will not be record unless the cash flow really comes into the account. So, there may have a delay for the company to figure out their accurate profit in this financial year. In accrual basis accounting, the income on credit will be put in to an accrual revenue account. When revenue is recognized after cash has been received, it is recorded in a deferred revenue account, such as unearned revenue. So, there will not be a delay of the income record and the company can get accurate account as the sales occur.
Expense is a necessary part of the income gathering process. (Hoggett, 2009 P130) In cash basis accounting, expense on credit will not be record. So, just like the income, the record will be delay. In accrual basis accounting, when an expense is record before cash flow really comes into the account, it will be recorded in an accrued expense account. (Bushman 2007) As a result, there will not have a delay in account. How can company choose their accounting method Most small businesses are free to choose either cash basis or accrual basis.
The cash basis accounting will be the best choice because it can save lots of expense in record-keeping. If you have a big company with lots of sales on credit. You need to use accrual basis accounting. (Fishman 2007) Big companies always have lots of sales on credit and purchase on credit, so the cash basis will have lots of delay caused by the time. In addition, big companies always have expense machines. If you use cash basis, the expense of the machine will be record to only this financial year.
However, if you use accrual basis accounting, the expenses will be record into many years and it is called depreciation. The record is more accurate. The revenue record principle requires that revenue need to be record when earned, not when the cash is received and this principal is very important for all companies. Conclusion I have identified the difference between cash basis accounting and accrual basis accounting. Both of them have their own advantages and disadvantages. So, it is very important for your company to choose which the most suitable one is.