Cash Basis of Accounting

In this system, the accounting entries are made on the basis of cash received or cash paid. In other words, transactions are recorded only when cash is received or paid. The incomes earned but not yet received (accrued income) or the expenses incurred but not yet paid (expenses outstanding) are completely ignored while preparing the final accounts.

For example, rent for the month of December, 1986 is paid in January, 1987. This is taken into the Profit and Loss Account of 1987 even though the benefit of that payment (accommodation) is enjoyed in 1986 itself.

Accrual basis of accounting

This system of accounting attempts to record the financial effects of transactions in the period in which they occur and not in the period in which the amount is received or paid by the enterprise.

Accrual accounting is also called 'Mercantile System of Accounting'. It recognizes the fact that buying, selling and all other operations of an enterprise during a period may not coincide with the period during which the related cash receipts and cash payments take place.

In other words, all revenues earned in a year may or may not have been received in cash in that year. Similarly, all expenses incurred in a year may or may not have been paid in the same year. Accrual accounting attempts to relate the revenues and expenses to the year in which they are actually earned or incurred. 

For example, rent for the month of December, 1986 is paid in January, 1987. As per the accrual principle, it would be taken into the Profit and Loss Account of the year 1986 and not 1987. This is more logical because the benefit of payment is enjoyed in the year 1986 and not in 1987. The main difference between accrual accounting and cash basis of accounting is the timing of recognition of revenues, gains, expenses and losses.