Definition of Cash Accounting
Cash Accounting refers to the accounting which involves the recording of business financial transactions in the books of accounts of entities at the time when the expenses are actually paid off, and the payment against the revenue is actually received by such entity, i.e. the expenses and incomes are only booked when the money is paid and received respectively by the business entity.
Explanation
Cash Accounting is one of the forms of recording the financial transactions that are done while doing the business. In a normal business operation, a business generates income for which they receive money and incur an expense for which they have to pay money. To know the financial position of the business, these transactions are recorded in the books of accounts of the company. So under the method of cash accounting, the financial transactions are recorded when the actual money is received and paid.
How Does Cash Accounting Work?
For recording the transactions using the cash accounting method, the entities prepare cash and bank ledger account. In such an account, receipts are matched with the payments, and the actual cash position at the end of the account statement is known. Basically, all the receipts of the business are added to the opening cash balance available, and the total of payments done are deducted from it to get the closing cash balance.
Example of Cash Accounting
Suppose there is a business whose name is Supreme software that provides services related to the software upgrades and others. Some transactions related to the business for the month of April and May 2020 are as follows:
- The opening cash balance on April 1st was $120.
- The advance of $50 is 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 that the business will receive in the month of May.
- On May 10th, a Payment of $100 is received for the service given on April 7th.
- On 16th May, the payment is done 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($) |
| April 2020 | April 2020 | ||||||
| 1 | To Bal b/d | 120 | 29 | By Computer Repair Service A/c | 150 | ||
| 15 | To Sale of Service A/c | 50 | 30 | By Bal c/d | 20 | ||
| 170 | 170 | ||||||
| May 2020 | May 2020 | ||||||
| 1 | To Bal b/d | 20 | 16 | By Electricity Expense A/c | 40 | ||
| 10 | To Sale of Service A/c | 100 | 30 | By Bal c/d | 80 | ||
| Total | 120 | 120 | |||||
Who Uses Cash Accounting?
The following business uses the cash basis of accounting:
- Small business enterprises maintain a very low or no inventory in the business like a business with low infrastructure and little use of plant & Machinery, and the business is interested in using a single entry system.
- The business where the number of employees is very less.
- Generally, small business enterprises that are sole proprietorship firms opt for a cash basis as they are privately held and are not required to publish their financial statements in public.
- Enterprises that do not require an audit.
Cash Accounting Entries
Some Regular Journal Accounting Entries are as follows:
| Journal Entries | |||
| Date | Particulars | Debit($) | 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 actually 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 actually made in case of expense or money is actually received in case of income/revenue.
- The cash basis of accounting is easy to incorporate as it is a single entry system, whereas Accrual accounting is difficult as compared to cash basis, and it uses a double-entry system of accounting.
- Cash basis only provides a picture of the actual cash and bank position of the business, whereas 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 accounting on a per cash basis as it is a single entry system of accounting.
- To do the accounting on a cash basis, complex and expensive accounting software is not required, which saves the cost of business.
- IT does not require any professional to record transactions as it is so simple; thereby, the cost of hiring a professional is saved.
Disadvantages
Some of the disadvantages are given below:
- The actual financial position of profit & loss of the business is not known in this method.
- The results that appear are not true and fair.
- The financial statements made using a cash accounting basis are not useful for the public and cannot be used by the investors to evaluate the business’s performance.
Conclusion
Thus, the Cash basis of accounting is the simplest form of recording the financial business transactions where only the transactions the of revenues that are received in cash and the expenses that are 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 very small scale.
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