Basis of accounting

"Accounting method" redirects here. For the computer science method, see Accounting method (computer science).
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In accounting, a basis of accounting is a method used to define, recognise, and report financial transactions.[1] The two primary bases of accounting are the cash basis of accounting, or cash accounting, method and the accrual accounting method. A third method, the modified cash basis, combines elements of both accrual and cash accounting.

  • The cash basis method records income and expenses when cash is actually paid to or by a party.
  • The accrual method records income items when they are earned and records deductions when expenses are incurred.
  • The modified cash basis records income when it is earned but deductions when expenses are paid out.

Both methods have advantages and disadvantages,[2][3] and can be used in a wide range of situations.[4] In many cases, regulatory bodies require individuals, businesses or corporations to use one method or the other.

Comparison

Comparison of accounting bases
Scenario Overview Cash accounting Accrual accounting
The company has received advance payment for obligations they have yet to perform Paid but unearned revenue Cash Received is recognised as income Cash paid to company is recognised as deferred income, a form of liability
The company has made advance payment for obligations the other party has yet to perform Paid but unearned expenses Cash paid is recognised as expenses Cash paid by company is recognised as deferred expenses, a form of asset
The company has already performed obligations but have yet to be paid Earned but unpaid revenue No revenue is recognised until cash is paid Cash paid is recognised as accrued income, a form of asset
The company has not yet paid for obligations already performed Earned but unpaid expenses No expense is recognised until cash is paid Cash paid is recognised as accrued expenses, a form of liability

Accrual basis

The accrual method records income items when they are earned and records deductions when expenses are incurred.[5] For a business invoicing for an item sold or work done, the corresponding amount will appear in the books even though no payment has yet been received. Similarly, debts owed by the business are recorded as they are incurred, even if they are paid later.[6]

The accrual basis is a common method of accounting used globally for both financial reporting and taxation. Under accrual accounting, revenue is recognized when it is earned, and expenses are recognized when they are incurred, regardless of when cash is exchanged.[7]

In some jurisdictions, such as the United States, the accrual basis has been an option for tax purposes since 1916.[5] An "accrual basis taxpayer" determines when income is earned based on specific tests, such as the "all-events test" and the "earlier-of test".[8] However, the details of these tests and the timing of income recognition may vary depending on local tax laws and regulations.

For financial accounting purposes, accrual accounting generally follows the principle that revenue cannot be recognized until it is earned, even if payment has been received in advance.[7] The specifics of accrual accounting can vary across jurisdictions, though the overarching principle of recognizing revenue and expenses when they are earned and incurred remains consistent.[9]

Modified cash basis

The modified cash basis of accounting, combines elements of both accrual and cash basis accounting.

Some forms of the modified cash basis record income when it is earned but deductions when expenses are paid out. In other words, the recording of income is on an accrual basis, while the recording of expenses is on the cash basis. The modified method does not conform to the GAAP.[10]

See also

References

  1. ^ "California Department of General Services". www.dgs.ca.gov. Retrieved 10 September 2024.
  2. ^ "Cash vs. Accrual Accounting", Inc.com
  3. ^ "Measuring the Deficit: Cash vs. Accrual" Archived 15 October 2013 at the Wayback Machine, GAO.gov
  4. ^ "Measuring the Deficit: Cash vs. Accrual". Government Accountability Office. Archived from the original on 15 October 2013. Retrieved 19 January 2011.
  5. ^ a b Treas. Reg., 26 C.F.R. § 1.446-1(c)(1)(ii)
  6. ^ root. "Accrual Accounting Definition | Investopedia". Retrieved 7 October 2015.
  7. ^ a b "What is the meaning of accrued in accounting?". Simplestudies LLC. 25 February 2010. Retrieved 25 February 2010.
  8. ^ Treas. Reg., 26 C.F.R. § 1.446-1(c)(1)(ii)(A); Revenue Ruling 74–607; Flamingo Resort, Inc. v. United States, 664 F.2d 1387 (9th Cir. 1982).
  9. ^ Choi, Frederick (2012). International Accounting. Pearson. ISBN 978-0132568968.
  10. ^ Ernst, James. "3 Methods of HOA Accounting and How They Effect Financial Statements". ECHO. Archived from the original on 8 August 2014. Retrieved 5 August 2014.