The cash basis and the accrual basis are the two basic methods of accounting. Each method identifies a different set of rules for recognizing revenues and expenses. The accrual basis of accounting means that revenues, expenses, and other changes in assets, liabilities, and owners’ equity are accounted for in the period in which the economic event takes place, not when the cash inflows and outflows take place. Alternatively, the cash basis of accounting means that revenues and expenses are not recognized until the cash is received or paid.
The Accrual Basis Of Accounting
As we noted, the best matching of revenues and expenses takes place when the accrual basis of accounting is used. This means that the financial effects of transactions and economic events are recognized by the enterprise when they occur rather than when the actual cash is received or paid by the enterprise. For example, sales are recognized as revenues when they are made, and services are recognized when they are performed, regardless of when the cash from that sale or service is actually collected.
That is, a sale on the account is recognized in the same manner as a cash sale is. The only difference is that Accounts Receivable rather than Cash is increased or debited at the time of sale. When the cash from the sale on the account is collected, no revenue is recognized. The cash collection is just an exchange of one asset, Accounts Receivable, for another asset, Cash. At this point, the total amount of assets remains the same. The revenue and asset increases were recognized at the time the sale took place.