Guest post by Peter Baskerville.
Accrual and cash-based accounting each represent two different approaches that can be followed when entering the financial transactions (particularly revenue and expense) into the double-entry bookkeeping system. Each approach produces different financial results for an organization as detailed on their financial reports.
Under the accrual-based approach, revenue and expense transactions are recorded in the double-entry bookkeeping system as they are earned and incurred, regardless of when the cash relating to those transactions actually takes place.
Under the cash-basis approach, the recording of the revenue and expense transactions is delayed until the cash from revenue is actually received and the expenses are actually paid.
If you like, the accrual-based approach is proper accounting in that the revenue earned is recorded in the month that it is actually earned and the expenses incurred in earning that revenue are recorded in the same month. This approach that appropriately matches revenues with expenses incurred, produces a more accurate profit/performance report of the organization’s activities. For this reason, large public companies are usually required by law to use this approach.
The cash-basis approach is a simpler system to administer but it is compromised accounting in that it does not adhere to one of the key principles of accounting, the matching principle. The matching principle directs produces of financial reports to match revenue earned with the expense incurred in earning that revenue, in the month where the financial event actually took place. However, law-makers and the accounting standards do allow this cash approach to be adopted by small businesses and government departments simply because the cost of engaging professional accountants to maintain the accrual-accounting approach is just too prohibitive and the cost-benefit cannot be justified.
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