Excel for
Chartered Accountants
What is Cash Basis of Accounting?
In accounting, there are two methods of accounting that can be used to record transactions. The Accrual Basis and secondly the Cash Basis of accounting. The elements recognized in cash basis are income and expenditure.
In Accrual basis of accounting income and expenditure are recognized when they are earned or incurred respectively even if the resulting cash in or out flow take place in a different accounting period. As against this in cash basis of accounting, income and expenditure are recorded when the cash is received or paid respectively. Thus in cash basis of accounting, the income or expenditure recognition is based entirely on the actual cash flow.
Difference between Cash basis and Accrual basis of accounting
The following example shall illustrate the application of cash basis in contrast with the accrual basis in computing the operational results of a business that sells goods on a mark up of 15% on purchase price
Example:
|
Date |
Transactions |
Quantity |
Rate |
Amount |
|
01-05-2015 |
Purchase made in cash |
100 |
100 |
10000 |
|
05-05-2015 |
Purchase made on credit |
100 |
100 |
10000 |
|
07-05-2015 |
Goods sold on credit |
80 |
115 |
9200 |
|
20-05-2015 |
Goods sold in cash |
50 |
115 |
5750 |
|
20-05-2015 |
Office Computer bought in cash |
1 |
25000 |
25000 |
Operational Results-May-2015:
|
|
Cash basis |
Accrual basis |
|
Sales |
5750 |
14950 |
|
Cost of goods sold |
10000 |
13000 |
|
Computer purchased |
25000 |
- |
|
Depreciation on computer |
- |
1250 |
|
Total Expenses |
35000 |
14250 |
|
Profit/(Loss) for the period |
(-) 29250 |
+ 700 |
|
Profit/(Loss) % |
(-) 508.69% |
+4.68% |
Here, we can see the impact of the cash basis on the operating results. What could be a profit under accrual basis turns out to be a whopping loss in cash basis of accounting simply due to the fact that it does not follow matching concept or distinguish between capital or revenue expenditure.
Common misconceptions about Cash Basis of Accounting:
However, the following are some basic misconceptions that people have with respect to cash basis of accounting.
Does Cash Basis of accounting follow Matching Concept?
No. Matching Concept is an inherent part of the accrual basis of accounting. The Matching Concept makes it imperative that we match all expenses against the revenue that they help to generate. Under the Matching Concept, expenses are recognised in the same period in which revenue associated with those costs are recorded. The matching concept is core to the Accrual Basis of accounting whereas it is an alien to Cash Basis where expenses and income is recorded based on flow of the cash. In Cash Basis the income received during a period is not linked with associated costs.
Does Cash Basis of accounting distinguish between Capital and Revenue Expenditure?
No. Cash Basis does not make any distinction between capital or revenue expenditure. As the matching concept is not applicable to the cash basis of accounting, it does not make a distinction between revenue or capital expenditure. For example a computer purchased shall be charged to income at the time of its purchase. Whereas under accrual basis, it shall be depreciated over its useful life.
Does Cash Basis of accounting permits recording of elements other than revenue and expenditure?
No. In the cash basis of accounting, receipts are considered as income of the accounting period in which they are actually received and payments are recorded as expenses of the accounting period in which they are actually paid. Also matching concepts and distinction between revenue and capital expenditure are not applicable. Thus in other words, following cash basis of accounting, there can’t be any debtors, creditors, stock advances, fixed assets, work in progress and equity. Elements like assets, liabilities, equity are not recognised in cash basis.
Do Financial Statements prepared on Cash Basis reflect True and Fair View?
No. For the reasons stated above, the financial statements prepared following cash basis of accounting do not reflect a true and fair view of the financial position or operational results of the reporting entity. Almost all of the statutes around the world governing corporate entities, makes it imperative that the financial statements represent a true and fair view.
International Practices with respect to Cash Basis Accounting:
Presently, almost all the countries recognizes accrual basis of accounting as the acceptable accounting basis which reflects the true and fair view of the state of affairs and of the operational results of the reporting entity.
The Conceptual Framework for Financial Reporting issued by International Accounting Standard Board (IASB) recognizes accrual basis of accounting as reflecting the true financial performance of the reporting entity.
It is to be noted that IASB has in May 2015 issued a Exposure draft on exploring possible changes to its Conceptual Framework for Financial Reporting. The discussion paper is open for public comment till 26 October, 2015. See Exposure Draft Click Here >> As the name suggest, the conceptual framework is the axis around which IASB develops and revises IFRS
Difference between Cash Basis of Accounting with Accrual Accounting. Meaning, Misconceptions and applicability of Matching Concept and True-Fair View
