Updated July 14, 2023
Definition of Cash Accounting
Cash Accounting refers to accounting that involves the recording of business financial transactions in the books of accounts of entities at the time when the expenses are paid off. The payment against the revenue is received by such entity, i.e., the costs and incomes are only booked when the business entity pays and receives the money.
Explanation
Cash Accounting is one of the forms of recording the financial transactions done while doing business. In a regular business operation, a company generates income for which they receive money and incur an expense they must pay. These transactions are recorded in the company’s books of accounts to know the business’s financial position. So under the cash accounting method, the financial transactions are recorded when the actual money is received and paid.
How Does Cash Accounting Work?
The entities prepare cash and bank ledger accounts to use the cash accounting method to record transactions. In such an account, receipts are matched with the payments, and the actual cash position at the end of the account statement is known. All the business receipts are added to the available opening cash balance, and the total payments are deducted to get the closing cash balance.
Example of Cash Accounting
Suppose a Supreme Software business provides services related to software upgrades and others. Some transactions related to the company for April and May 2020 are as follows:
- The opening cash balance on April 1st was $120.
- The advance of $50 was received on April 15thfor which the services were provided in May.
- A payment worth $150 is made on April 29th for the computer repair service the business will receive in May.
- On May 10th, a Payment of $100 is received for the assistance given on April 7th.
- On May 16th, the payment was made for the electricity bill amounting to $40 related to the month of April.
- Now we need to record the above transactions in the business books of accounts.
| Journal Entries | |||||||
| Date | Particulars | Debit ($) | Credit($) | ||||
| 15-Apr | Bank A/c Dr | 50 | |||||
| To Sale of Service A/c | 50 | ||||||
| (being the sale of service is recorded) | |||||||
| 29-Apr | Computer Repair Service A/c Dr | 150 | |||||
| To Bank A/c | 150 | ||||||
| (Being advance paid for computer repair service) | |||||||
| 10-May | Bank A/c Dr | 100 | |||||
| To Sale of Service A/c | 100 | ||||||
| (Being sale recorded) | |||||||
| 16-May | Electricity Expense A/c Dr | 40 | |||||
| To Bank A/c | 40 | ||||||
| (Being Electricity Bill for April Month is Paid) | |||||||
| Debit | Credit | ||||||
| Date | Particulars | L.F. | Cash($) | Date | Particulars | L.F. | Cash($) |
| April 2020 | April 2020 | ||||||
| 1 | To Bal b/d | 120 | 29 | By Computer Repair Service A/c | 150 | ||
| 15 | To Sale of Service A/c | 50 | 30 | By Bal c/d | 20 | ||
| 170 | 170 | ||||||
| May 2020 | May 2020 | ||||||
| 1 | To Bal b/d | 20 | 16 | By Electricity Expense A/c | 40 | ||
| 10 | To Sale of Service A/c | 100 | 30 | By Bal c/d | 80 | ||
| Total | 120 | 120 | |||||
Who Uses Cash Accounting?
The following business uses the cash basis of accounting:
- Small business enterprises maintain a very low or no inventory, like a business with inadequate infrastructure and little use of plant & Machinery. The company is interested in using a single-entry system.
- The business where the number of employees is significantly less.
- Generally, small business enterprises that are sole proprietors opt for a cash basis as they are privately held and are not required to publish their financial statements publicly.
- Enterprises that do not require an audit.
Cash Accounting Entries
Some Regular Journal Accounting Entries are as follows:
| Journal Entries | |||
| Date | Particulars | Debit($) | Credit($) |
| Bank A/c Dr | – | ||
| To Sale of Service A/c | – | ||
| (being the sale of service is recorded) | |||
| Purchases A/c Dr | – | ||
| To Bank A/c | – | ||
| (Being Purchases are made in cash) | |||
| Bank A/c Dr | – | ||
| To Interest Income A/c | – | ||
| (Being Interest on Fixed Deposit is received) | |||
| Electricity Expense A/c Dr | – | ||
| To Bank A/c | – | ||
| (Being Electricity Bill is Paid) | |||
| Salary A/c Dr | – | ||
| To Bank A/c | – | ||
| (Being Salary Paid to employees) | |||
Cash Accounting vs Accrual Accounting
- In Cash basis of accounting, the accounting transactions are recorded when the amount against such transaction is paid or received, whereas, in the case of accrual accounting, the accounting transactions are recorded when the transaction occurs regardless of the date when the payment is made in case of expense or money is received in case of income/revenue.
- The cash basis of accounting is easy to incorporate as it is a single-entry system. In contrast, Accrual accounting is more complex than cash-based and uses a double-entry accounting system.
- The cash basis only shows the business’s actual cash and bank position. In contrast, the actual financial position, i.e., profit and loss of the company, is known using an accrual basis only.
Benefits
Some of the benefits are given below:
- It is easy to do cash-based accounting as it is a single-entry accounting system.
- Complex and expensive accounting software is not required to do the accounting on a cash basis, saving the business’s cost.
- I.T. does not require any professional to record transactions as it is so simple; the cost of hiring a professional is saved.
Disadvantages
Some of the disadvantages are as follows:
- This method does not know the actual financial position of the profit & loss of the business.
- The results that appear are not true and fair.
- The financial statements prepared using a cash accounting basis do not provide valuable information for the public, and investors cannot utilize them to assess the business’s performance.
Conclusion
Thus, the Cash basis of accounting is the simplest form of recording financial business transactions where only the transactions of revenues received in cash and the expenses paid in cash are recorded. Because of the disadvantages of cash basis over accrual basis, very few enterprises use this method of accounting, like sole proprietorship firms, etc., that operate at a tiny scale.
Recommended Articles
This is a guide to Cash Accounting. Here we also discuss the introduction, how cash accounting works, and its benefits and disadvantages. You may also have a look at the following articles to learn more –
