What is Cash Basis Accounting? [Simple Explanation]

Two accounting methods are used to record transactions regardless of cash or cash in hand. We saw how transactions are recorded in the accrual accounting method though we didn’t have cash in hand. But on a Cash basis accounting, we record transactions as income or expense only when we have cash in hand.

Also read: 7 Differences Explained on Cash Basis vs Accrual Basis

What is Cash Basis Accounting? Definition

A cash basis of accounting is one of the two accounting methods that records income and expenses only when the cash is received.

This is not the same with the Accrual basis of accounting; On an accrual basis, the transaction is recorded as income or expense when the transaction is initiated, and though you don’t have the cash in hand.

Let me make it more clear with an example,

Suppose I manufacture toys and a wholesaler wants to buy 1000 pieces from my firm and also today is the last date of the current financial year. If the wholesaler pays me 1000 pieces today, I record this transaction in the current financial year. If he/she pays me tomorrow, then the transaction is accounted for in the next financial year. On a cash basis, the transaction is noted only when the money is received.

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Should You Implement this Method of Accounting?

Cash basis and Accrual basis are two types of accounting; though cash basis is easy because you account for the transaction only when the cash is received, it is not accurate and can create a fuss. On the other hand, the accrual basis of accounting helps you accurately record the income and expenses for the financial year.

This method of accounting is useful because

  • It is easy to implement
  • Easily understandable
  • Single-Entry System
  • Shows the cash flow

But the IRS restricts businesses to use “Cash Basis” because it is a short-term measurement and does not reflect the company’s exact financial condition. On a cash basis, you cannot measure the pay you will earn or expenditure in the future. But using accrual, you can calculate the company’s financial condition more accurately, including the future transactions of the projects you have already started but haven’t earned income for.

Also read: What is Debt to Asset Ratio – Simplest Explanation + Example]

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Frequently Asked Questions

What is cash basis of accounting?

A cash basis of accounting is one of the two accounting methods that records income and expenses only when the cash is received.

What are the disadvantages of cash basis?

The disadvantages of cash basis are, it is short-term, not accurate, and restricted by the IRS.

What are two basis of accounting?

The two basis of accounting are, cash basis and accrual basis.

Is it easy to implement cash basis?

It is easy to implement cash-based accounting, but it is not accurate compared to an accrual basis.

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