To a student cash basis of accounting seems to be more logical because in this system only cash transactions are recorded and the profit or loss calculated is more certain as no adjustments are...

To a student cash basis of accounting seems to be more logical because in this system only cash transactions are recorded and the profit or loss calculated is more certain as no adjustments are required. Explain to a student how it is not logical or scientific.

Asked on by afsheen123

1 Answer | Add Yours

gsenviro's profile pic

gsenviro | College Teacher | (Level 1) Educator Emeritus

Posted on

The cash basis of accounting is the accounting method where records are made/updated only when cash exchanges hands, i.e. either the person (or business) receives cash or spends cash. This method of accounting is preferred by individuals or small business, whereas large businesses prefer accrual basis of accounting (where income and expenses are recorded as they happen with or without exchange of cash).

The cash basis of accounting suffers from accuracy issues because of the timing of cash flows. For example, one can purchase on credit and pay later, however the transaction will not be recorded until the actual cash payment is made. Say one has $1000 in cash and purchases a $2000 laptop on credit. His accounts will show that he has $1000, while in reality he (on net basis) owes $1000 ($2000-$1000). So his records will show +$1000, instead of -$1000. Similarly, if the student is working freelance and accepts an Android App design project for $5000 (from Jan-Mar) and spends $2000 on hardware to start the work (say in Jan). His books will show a loss of $2000 for Jan and gain of $5000 for Mar, while in reality he has a net gain of $3000. Also, cash basis of accounting is open to manipulation, for example the person can defer cashing out his check to defer his tax liabilities. 

Hence, cash basis of accounting may not be accurate. 

We’ve answered 318,928 questions. We can answer yours, too.

Ask a question