Acknowledgement of cash only when it is received, and deduction of expenses when they actually happen, is known as the cash basis accounting method. In other words, when a cash payment is received, a company records that transaction at the time when the cash is actually given. When an expense is paid, a company deducts that payment at the time the expense is paid. Using the cash method provides an exact idea of how much actual cash a company has; however, it can often present an ambiguous picture of a company's long-term profitability (Nolo.com, 2008).
With the accrual method, transactions are recorded when the order is completed, an item is delivered, or a services is given, despite of when the money is physically received or paid. In other words, income is calculated when the sale takes place, and expenses are recorded when goods or services are received. Companies do not have to wait until the money is physically given, or a payment physically made in order to record a transaction (Weygandt, J.,
Kieso, D., Kimmel, P., 2006).
Differences between cash and accrual accounting include details such as; accrual basis of accounting will reveal a more accurate picture of the long-term financial position, while cash based accounting requires less input of details because only cash in and cash out are recorded. Cash based accounting can create confusion with retail inventory and prepaid situations because these transactions require documentation within several periods instead of one. Therefore, the cash based accounting is generally used on an individual or small company basis (Weygandt, J. et. al., 2006).
With accrual accounting, recording of the transactions are more cumbersome because payments made for an entire year are documented throughout that year instead of just once, as in cash based accounting (Nolo.com, 2008). Larger companies use this...