Friday, May 27, 2022

Cash Basis of Accounting Vs Accrual Basis of Accounting

What are the differences between cash basis of accounting and a credit basis of accounting what they mean exactly we're gonna cover this one the differences between them the advantage and disadvantage of them and example and practice question in this video be with us till the end of the .

Video this is milad akbari from akubar education welcome to our channel as i told you we're gonna cover the differences between cash basis of accounting and accrual basis of accounting exactly the differences the merits and demerits .

Example and practice question as always let's jump what we're gonna cover in this video the difference merits and demerits example and practice question will be the areas we're gonna cover in this video for the first point these are the methods of recording the financial .

Transactions and reporting them suppose when i sold something should i go and record that or should i wait when the cash is received so two methods exist one of them will say one thing and another one will say one thing and they gonna manage the financial system of the company as .

Per that basis uh the differences will arise on the timing of when the sales and purchase will be done and when you're gonna receive the cash or you're gonna actually pay the cash for the expenses incurred but one thing is clear that after a .

Period of time the result should be the same let me clarify that with an example suppose i uh i'm following the uh acquired base of accounting i sold something on the um first december 2020 and i gonna receive that cash in 31st december 2021. .

Then i'm gonna record that on accurate base of account that's my revenue i have earned that i will recognize that but the company was following the cash basis will not recognize that and he will be waiting until next year 31st january 2021 to consider that as a revenue .

That's the difference but overall he gonna record this supposed ten thousand dollar as the income of the company and the other company which follow the cash basis of accounting will also recognize that he received a revenue of ten thousand dollar so the end result is the same suppose a company .

Which has the overall hundred thousand dollar during the period he gonna show that he have a hundred thousand dollar revenue but whether he receives all the cash at the same time other company with the same purpose have income of hundred thousand dollar but he didn't receive that fifty thousand dollar it's as .

Account receivable of the company at the year end december 2020 but the end result is here that he will have the hundred thousand dollar when he received the cash and he will have the hundred thousand dollar the same when he received the cash but the timing of reporting that will be .

Different at the end they will say they have the same revenue whether the cash is received or not but when the cash is received the results will be equal let's go to specifically the differences between them the cash accounting recognizes revenue .

When the cash has been received so the cash basis of accounting will say this is my revenue when i actually receive that cash in my hand but inaccurate base of accounting they don't care about when they are going to receive the cash they will only recognize .

When the basis of recognition has been covered they have sent the invoice and they have delivered the product or the service or whatsoever then they're gonna recognize of course uh there's a standard international financial reporting standard 15 ifrs 15 which .

In detail will discuss how an accountant should recognize revenue how to recognize when to recognize and how to record that be with the channel we're gonna cover that ifrs 15 in detail but and it's time let's continue recognize the expenses when the cash has been paid under the cash basis of accounting .

So under the cash basis of accounting when i pay actually for the expense i gonna record that but need accrual base of accounting this month ended and this expenses belong to this month then i gonna record whether i pay cash for that or no suppose and on cash basis of accounting .

After a quarter three months january february and march i gonna pay the three-month rent at the same time as a three thousand dollar then i'm gonna record it in the cash piece of accounting as the rent expense but accurate base of accounting will split that three thousand dollar as one .

Thousand for the january 1000 for the february 1000 for the month of march and they're gonna record that one thousand dollar in the january whether they paid or no they will regard that as the rent expense and in consideration to that they will increase the level of their payable .

That they need to pay that's why they will come across to end of march and they're gonna pay that account payable back to the supplier of the room or the supplier of the place and as a name of their rent expense and they will decrease their payable third area based on the .

Law of the country rules and regulations allowed for the companies if the taxation is based on the cash basis of accounting they will pay the taxes for only for the income they have received in their hand as a cash so for the cash .

Received they will pay the taxes but if the country followed the accurate base of accounting they're gonna pay the taxes for the income that they have recognized even the possibilities there that they will not receive that income .

For the forcing per year maybe after two months suppose i give the example up they will receive under january but they need to pay on december the tax is relevant to the revenue they have recognized the cash base of accounting mostly used by small businesses by businesses which has lots of retail transactions such as .

Supermarkets small shops they're gonna do the cash basis of accounting that's simple for them but the accurate base of accounting nowadays is used by large companies large corporations they have the transactions with big .

Customers big customers will come to them they they're going to sell to them and they will receive after a period of credit term and that's it let's go to the merits and the email rates base of accounting the based on simple merit of cash lists of accounting is .

That you know your liquidity you know your cash position you know how much cash you have and you will go as per that to spend you know how how much cash you have received during the period but under the uh accrual base you know they will show .

How much is the revenue earned maybe the cash base basis not matching to that we will come to that the first one you know that your liquidity and cash position better no taxes payable on the cash you have not received that so the cash the tax will be paid .

On the day or on the period you're gonna receive the cash for that uh it's of course much more simple much more easy to understand because you are recording the revenue on the cash you have actually received of course there are some demo rates uh one of them one of the most important .

One is the company of the company follow the cash basis of accounting and they sold something on loan they don't know uh what is the level of receivable they're gonna have at the end of the period or even at that same moment because they have sold something and they will .

Not recognize any revenue up to the time they receive the cash so there is no record of account receivable and account payable inside the company nowadays the level of applicability of the cash base of accounting is uh decreasing it's declining and most of the companies even the .

Public sector are shifting to the accrual base of accounting and at the same time it will not show the clear position of the company suppose i have purchased a computer for five thousand dollar and during 2020 then i gonna record that on the cash .

Basis of accounting as an expense as a purchase i did once and this is the cash outflow to the business but i will utilize that five thousand dollar computer during five years they will not show a clear position of how much value of that computer is remain in end of year 2021 that's .

A big demo rate of that let's go to the accurate days of accounting some merits that's much more uh applicable now they will show the accurate status and position and financial reporting of the company of course i gave you the example of a computer at .

Year end 2021 i know what is my position how much the value of that computer has been expensed as a depreciation and how much value of that computer is remaining at as the name of net realizable value or net book value of that uh computer at the end of .

2021. it's highly applicable i told you most of the countries public sector and private sector are shifting toward that now it's the modern uh used system of accounting even most of accounting system accounting information systems .

Are shifting toward that and they use the accurate base of accounting so that's much more applicable now highly applicable now of course when it's more more applicable we have more standards for that and the standards are much more up-to-date .

To the system of the world and what's going on in the world you know there are recent changes such as ifrs 16 which are the modern changes and there are is ifrs which show you how to do that so it's much more standardized than the .

Cash basis of accounting of course some demerits exist the easiest one and important one is that revenue report or profit report is not matching your bank tone you showed that you have a 5 000 profit during this period is this amount available in your bank account on .

The cash base you will report the profit which is available which is the cash base which is the actual amount inside your bank account but that's not the case uh of uh accurate base of accounting so the profit or revenue you're recording and reporting .

Is not matching with the cash available inside your bank account and if the taxes are paid based on the accrual basis of accounting the biggest demerit is here that you're gonna pay the tax on the revenue which you have not received the cash for so for the cash you have not received .

You're gonna pay the taxes uh for the government and the last point it's a bit complicated when there are more standards when it's dealing with the up-to-date uh basis of systems accounting and what's going on in the world then of course it's .

Complicated it's going to deal with depreciations it's going to deal with accrual um and some prepayments and unearned revenues and dealing with lots of areas which is complicated be with us with this channel we're gonna cover all these areas and it's time but of .

Course it's complicated but more accurate as a merit of that uh let's have an example suppose we send an advice to customer for one thousand dollar for the work done during this month on the cash basis of accounting if the cash is received okay we're going to record that if the cash is not .

Received only we have sent the invoice then it will not be recognized and it will not be recorded but for the accurate base of accounting we are going to record that because we have done the work and we have sent the invoice uh to the supply to the customer that's why we're gonna record that one .

Thousand dollars as a revenue of the business same received bill from supplier for eight hundred dollar for subcontractor did the work this month and there is subcontractor who provided some a job for us we're gonna record that whether we pay the cash or not we're gonna recognize that we're gonna .

Match that with the revenue it's earned that's under accurate basis for gandhi but cash base of accounting gonna consider that when actually they paid for that purchase and at the moment uh we receive uh cash from the customer for 500 then under cash basis of accounting .

We gonna regard that as a revenue actual revenue but under accurate base of accounting if that's for the service provided during the period or the product provided provided during the period then they're going to record that as a revenue but there is increase in revenue and .

There is increase and on cash at the same time but suppose i did not receive any amount for that but i gonna receive next month then on that month that i have provided the service and product and then and and goods i gonna record that as a revenue .

Because i have recognized that an under accurate base of accounting but when i receive the actual cash for that i gonna record that my receivable decrease and my level of cash increase for the same case paid cash to the supplier for 700 .

And their cash base of accounting i paid that cash then i got a record as expense but an accurate base of accounting if the service is delivered to me at the same period i'm gonna record this is my expenditure and this is the cash i have paid for that .

But the case is different when you receive the service on an previous period now you are paying for that you have already recorded that as expense during that period in this period you will decrease your payable because you are paying it now we have .

As always we have some practice questions uh the first one is under the accurate basis of accounting revenues are reported in the accounting period when under the accrual piece of account recommend pause the video think of that come with the answer .

But to continue we have the options caches received and required based of accounting revenue is reported and cash is received i don't think so service or goods have been delivered this is the case you're gonna recognize the revenue when the goods or service .

Is delivered fully and the third one end of the month has arrived no customer space no so the right answer is option two let's go to the next one reporting income when the cash is received and the expenses when the cash is paid is called what pause the video think of that review the answers and come back but to .

Continue accrual basis of accounting no that's different we have already studied that you can review the video once again cash basis of accounting of course they gonna record the revenue when the cash is received and they're gonna record the expense .

When the cash is actually paid fiscal period and trial balance are totally different so thank you so much for being with us till end of the video i wish you have learned these two different methods one thing i'm requesting you is to subscribe to our channel press the notification button we're .

Gonna have weekly videos on entrepreneurship on success motivation and different areas which is required for the business whether accounting auditing costs accounting whatsoever it will be covered on weekly videos so uh important than that share this with your friend let's grow all together thank you .

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