What is the difference between cash basis accounting and accrual accounting?
Cash basis accounting is a method of recognizing revenue and expenses when cash is received or disbursed rather than when earned or incurred. Businesses may use either cash basis which is also known as cash system of accounting or the accrual basis of accounting to report revenues and expenses. Using the cash basis of accounting, a business would report revenues only when cash is received and expenses only when cash is disbursed. Net income is the difference between cash receipts and disbursements. This method may be acceptable for some small businesses, but its use is generally discouraged.
Accrual accounting is the recognition of revenue when earned and expenses when incurred. Businesses using the accrual basis of accounting report revenues in the period in which they are earned (even if the cash is received in the next accounting period). Under this basis, expenses are reported in the period in which they are incurred, not when cash is paid out. As an example, assume that a business reports income and expenses on a monthly basis. Revenue from December sales would be reported as income during that month although cash for these sales may not be received until next month, January or the next accounting period. Expenses are recognized monthly as they are incurred. Generally Accepted Accounting Principles require the use of the accrual basis so that revenues recognized during a given accounting period are matched with related expenses incurred in that same period. This process if facilitated by an adjusting process performed at the end of each accounting period.