Cash Basis Accounting This is what "Based on Realization" We Most of us use the cash method to keep track of our

personal financial activities. The cash method recognizes revenue when payment is received, and recognizes expenses when cash is paid out. For example, our local grocery store's record is based on the cash method. Expenses are recorded when cash is paid out and revenue is recorded when cash or check deposits are received If we summarize, under the cash basis accounting, revenues and expenses are recognized as follows:

Revenue recognition: Revenue is recognized when cash is received. Expense recognition: Expense is recognized when cash is paid.

Take a note the word "cash" is not meant literally - it also covers payments by check, credit card, barter, etc. Moreover it is not standard method in compliance with accountings matching principle. Accrual Basis Accounting This is what "Based on Recognition" The accrual method of accounting requires that revenue be recognized and assigned to the accounting period in which it is earned. Similarly, expenses must be recognized and assigned to the accounting period in which they are incurred. Then the underline question is what is accounting Period, Let explain like this normally a company tracks the summary of the accounting activity in time intervals, which we normally called as Accounting periods. These periods are usually a month long. It is also common for a company to create an annual statement of records. This annual period is also called a Fiscal or an Accounting Year. In the accrual method relies on the principle of matching revenues and expenses. This principle says that the expenses for a period, which are the costs of doing business to earn income, should be compared to the revenues for the period, which are the income earned as the result of those expenses. In

other words, the expenses for the period should accurately match up with the costs of producing revenue for the period

Take a case: Company is doing a business and they have to pay sales commissions expense, so sales commissions expense should be reported in the period when the sales were made (and not reported in the period when the commissions were paid). Similarly, Salary/Wage to employees are reported as an expense in the week/month when the employees worked and not in the week/month when the employees are paid. If a company agrees to give its employees 2-month equivalent salary of its 2006 revenues as a bonus on January 25, 2007, the company should report the bonus as an expense in 2006 and the amount unpaid at December 31, 2006 as a liability. This is most simple kind of matching principal normally has.

In general, there are two types of adjustments that need to be made at the end of the accounting period. 1. The first type of adjustment arises when more expense has been recorded than was actually incurred or earned during the accounting period. 2. Similarly, there may be revenue that was received but not actually earned during the accounting period. Also known as Un-earned Revenue. The accrual method generates tax obligations before the cash has been collected (because revenue leads to tax and revenue is recognized against receivable and not against receipt of money). If we summarize, under the accrual basis accounting, revenues and expenses are recognized as follows

Revenue recognition: Revenue is recognized when both of the following conditions are met: o Revenue is earned i.e. when products are delivered or services are provided.

Revenue is realized or realizable. i.e. either cash is received or it is reasonable to expect that cash will be received in the future. Expense recognition: Expense is recognized in the period in which related revenue is recognized (Matching Principle).
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Timing differences in recognizing revenues and expenses Various accounting books did mention four potential timing differences in recognizing revenues and expenses between these of two. Just to recap of those: a. Accrued Revenue: Revenue is recognized before cash is received. b. Accrued Expense: Expense is recognized before cash is paid. c. Deferred Revenue: Revenue is recognized after cash is received. d. Deferred Expense: Expense is recognized after cash is paid.

Compare with a Case to explain these two methods Your company purchase a new Laptop on credit in May 2007 and pay $1,500 for it in July 2007, two months later. Under the both case see how this makes a difference: Using the cash method accounting, you would record a $1,500 payment for the month of July, the month when the money is actually paid. Under the accrual method, you would record the $1,500 payment in May, when you take the Laptop and become obligated to pay for it. Pros and cons of these Two accounting method Maintence: The cash method is easier to maintain because you don't record income until you receive the cash, and you don't record an expense until the cash is paid, where as in the accrual method, you will typically record more transactions. Cash-basis accounting defers all credit transactions to a later date. It is more conservative for the seller in that it does not record revenue until cash receipt. In a growing company, this results in a lower income compared to accrual-basis accounting.

Cash-based accounting means that sales are recorded when you receive the money, and expenses are recorded when they are actually paid. What benefit does cash based accounting provide? There are actually only a couple of benefits from using the cash based method accounting,

however if this method fits your business, it will save you money in bookkeeping expenses. If most of your sales are cash sales, you don't maintain an inventory, and you don't have customer accounts or returns, then the cash based method is a much better choice, because it's much easier and it's much cheaper to maintain. The greatest advantage to cash based accounting, allows an information manager, or if you're a small business, the business owner to quickly assess if the business is operating profitably, but only if the business is for the most part a cash business; with little or no inventory and cash sales. You can better assess profit levels when you use the accrual based method because you match income to expenses more accurate