Should Organisations adopt Accrual or Cash-basis Accounting?

In Cash basis accounting, Companies record revenue when cash is received and record expenses when cash has been paid. This seems appealing due to its simplicity but often produces misleading financial statements. It fails to record revenue that a Company has earned but for which it has not received the cash. It also doesn’t match expenses with earned revenues.

For accrual basis accounting, Companies record transactions that change their financial statements in the periods in which the events occur. Companies recognise revenue when earned and not when cash is received. Also expenses are recognised when incurred and not when cash is paid.

The two principles required in determining revenue and expenses in a given accounting period are:

i) Revenue Recognition principle:- this requires that Companies recognise revenue in the accounting period in which it is earned.

ii) Expense Recognition principle: this is tied to revenue recognition. The critical issue in expense recognition is when the expense makes its contribution to revenue.

Cash basis is justified for small businesses because they often have few receivables and payables.

Accrual basis accounting is more suitable for medium and large Companies