Definition of the Cash Basis of Accounting
- Revenues are reported on the income statement in the period in which the cash is received from customers.
- Expenses are reported on the income statement when the cash is paid out.
Definition of the Accrual Basis of Accounting
The accrual basis of accounting provides a better picture of a company’s profits during an accounting period for the following reasons:
- Revenues are reported on the income statement when they are earned, which often occurs before the cash is received from the customers.
- Expenses are reported on the income statement in the period when they match up with the related revenues, occur, or expire, which is often in a period different from the period when the payment is made.
The accrual basis of accounting also provides a better picture of a company’s financial position at the end of the accounting year. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported on the balance sheet.
The accrual basis of accounting is required because of the matching principle.
