The cash basis answers a question about the bank account. The accrual basis answers a question about the period. They are different questions, and only one of them is what a general-purpose financial statement is for.
A firm bills a client 40,000 in December and collects in February. Cash basis reports nothing in December and 40,000 in February. Accrual basis reports 40,000 in December, when the work was done, and reports the February receipt as a receivable turning into cash. Neither is arithmetic sleight of hand; they place the same 40,000 in different years.
The gap between the two bases is exactly the change in the balance sheet accounts that sit between performance and payment. Accrual revenue equals cash collected plus the increase in receivables. Accrual expense equals cash paid plus the increase in payables less the increase in prepaids. Every adjusting entry is one line of that reconciliation.
Small businesses and individuals often keep books on the cash basis because it is cheap and hard to argue with. It also lets a manager move reported income by timing a payment, which is one reason general-purpose reporting does not accept it.
Put the concept to work
Understand this concept
- Explain what the cash basis records and when, and say which period a given receipt or payment lands in under each of the two bases.
Apply this concept
- Convert a stated cash-basis figure to its accrual-basis equivalent, or the reverse, using the change in the related receivable, payable, or prepaid balance.
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Build on these ideas
- Accrual-basis accounting — Understand
To understand this concept: Required. The cash basis is defined by what the accrual basis does differently.
- Adjusting entry — Apply
To apply this concept: Required. The conversion is the adjusting entry stated as a difference.
- Cash basis accounting — Understand
To apply this concept: Required. Converting between bases requires knowing what each one records.
Show 1 more prerequisites
- Revenue — Understand
To understand this concept: Required. The two bases disagree about when revenue belongs to a period.
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Use this idea next
- Cash basis accounting — Apply
Required level here: understand. Required. Converting between bases requires knowing what each one records.
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