Basis of Accounting –
The basis of accounting refers to the method under which revenues and expenses are recognized in the financial statements of any organization. Businesses need to record transactions using one of two primary methods:
- Cash Basis
- Accrual Basis and;
- Hybrid Basis
Cash Basis of Accounting:
In this system, income is reported when it is actually received and expenses are recorded when they are actually paid. Cash basis method of accounting is not as accurate as the accrual basis in the long term. One advantage is that it is not required as complicated as the accrual basis. Small business may start with the cash-basis method of accounting and then slowly with the help of a professional accountant, switch to the accrual basis of accounting.
In this system income to be reported as soon as it is EARNED whether cash is received or not and expenses need to be recorded as they are INCURRED whether cash is paid or not. Accrual accounting results in an income statement that provides an accurate representation of the profitability of your business.
For example, if a company makes a large sale in the month of December’ 2019 but does not expect to receive payment until 31st January,2020 of the next calendar year, as per the accrual method of accounting the revenue from sale would be recorded in December.
Hybrid Basis of Accounting:
Some businesses use Hybrid basis methods, which combines principles from both the accrual- and cash-basis methods. In this method, income is recorded as it is earned, using the accrual method. And expenses are recorded when they are paid, as in the cash method of accounting. Although the modified cash-basis method does not comply with Generally Accepted Accounting Principles or GAAP, it brings together the best of both major methods of accounting.
For example, a dealer buys the goods in May for which he pays in June. Then payment will be recorded in June. Same goods he sells in June then income will also be recorded in June.
Thus, the basis of accounting is basically a choice of method of recording the transactions in books of accounts. It could be cash basis or accrual basis or hybrid.