The basis of accounting is the set of rules and principles that is used to prepare and maintain a company's financial records and statements. The two most commonly used bases of accounting are the cash basis and the accrual basis. The cash basis of accounting is a simple and straightforward method in which transactions are recorded only when cash is received or paid. This means that revenues are recognized when they are received, and expenses are recognized when they are paid.
Here is an example of how the cash basis of accounting might work in practice:
Suppose that a company called ABC Inc. provides consulting services to a client in March, and the client agrees to pay for the services in April. Under the cash basis of accounting, ABC Inc. would not recognize the revenue from the consulting services in March, because the money has not yet been received. Instead, the revenue would be recognized in April, when the payment is received.
The accrual basis of accounting is a more complex method in which transactions are recorded when they are earned or incurred, rather than when cash is received or paid. This means that revenues are recognized when they are earned, and expenses are recognized when they are incurred.
Here is an example of how the accrual basis of accounting might work in practice:
Again, suppose that a company called ABC Inc. provides consulting services to a client in March, and the client agrees to pay for the services in April. Under the accrual basis of accounting, ABC Inc. would recognize the revenue from the consulting services in March, when the services were provided, even though the money has not yet been received. The transaction would be recorded in the company's general ledger as a credit to the consulting services revenue account and a debit to the accounts receivable account.
In this way, the basis of accounting refers to the set of rules and principles that is used to prepare and maintain a company's financial records and statements. The cash basis and the accrual basis are the two most commonly used methods, and they each have their own unique characteristics and advantages.
