There are two major ways by which recording of income and expenses takes place in accounting. These are cash basis and accrual basis.
Cash basis method:
In the cash basis method, the expenses are recorded as the cash is paid and the income or revenue is recorded when the cash is received. This is the simplest method of recording the transactions and no amount of revenue is reflected in the account until and unless the payment has been received. If just in case a business in debt, it will be shown in the books only when the debt is paid off. But this method is only allowed for small businesses.
Accrual basis method:
In accrual basis accounting, it’s completely different. In it the revenue is recorded on the day it is earned and the expenses on the day they are incurred. Both of these aren’t concerned with the actual date of the cash flow. Just in case, the business has only transactions via cash then both accrual basis and cash basis will present the same results. Even if some credit transaction is done in the business at any time of the year the results will vary automatically.
Importance:
In IFRS, it is mandatory to utilize the accrual basis method for keeping an account of all the revenue and expenses. Let’s take an example of the scenario where the business has accounted a sale in 2016 but is going to receive the payment for it only in 2017. In this case, the sales will still be recorded for 2016, irrespective of the date when they receive the payment.
Under the IFRS system, except the cash flow system the underlying assumption for preparing the financial statements is on the basis of accrual basis method. This method is chosen, as it’s very flexible and provides a base for managing many opportunities to manipulate the financial statements.
