There are two basic accounting methods available in the business world.Cash or Accrual
Cash Basis Accounting:
With the cash method of accounting, you record income only when you receive cash from your customers. You record an expense only when you write the
check to the vendor. Most individuals use the cash method for their personal finances because it's simpler and less time-consuming. However, this method can distort your income and expenses, especially if you extend credit to your customers, if you buy on credit from your suppliers, or you keep an inventory of the products you sell. 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.
Accrual Basis Accounting:
With the accrual method, you record income when the sale occurs, whether it be the delivery of a product or the rendering of a service on your part, regardless of when you get paid. On the other hand, you record an expense when you receive goods or services, even though you may not pay for them until later.
The accrual method gives you a more accurate picture of your financial situation than the cash method. This is because you record income on the books when it is truly earned, and you record expenses when they are incurred. Income earned in one period is accurately matched against the expenses that correspond to that period, so you get a better picture of your net profits for each period.
Under the accrual basis accounting, revenues and expenses are recognized as follows:
•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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