The Two Methods of Accounting
When should income be recorded in the books — when you raise the invoice or when the customer pays? That single question separates the two main bases of accounting.
Cash Basis
Income is recorded when cash is received and expenses are recorded when cash is paid. Nothing happens until money actually moves.
Accrual Basis
Income is recorded when it is earned (you've delivered the goods or services) and expenses are recorded when they are incurred (you've consumed the benefit) — regardless of whether the cash has moved.
Cash Basis in Detail
Pros:
- Extremely simple — no adjustment entries for prepaid, outstanding, accrued or unearned items
- Tracks actual cash flow, which is what matters for paying bills
- Well suited to small enterprises where most transactions are cash-based
Cons:
- Does not give a true and fair view of profit or financial position
- Violates the matching principle — March's invoice paid in May appears in May's P&L
- Misleading for credit-based businesses that have lots of debtors and creditors
Accrual Basis in Detail
Pros:
- Shows the complete picture — including amounts you've earned but not yet collected and amounts you owe but haven't paid
- Discloses correct profit or loss for the period
- Exhibits the true financial position
- Required by Indian Companies Act for companies and recommended for any growing business
Cons:
- Requires adjustment entries at period end (outstanding, prepaid, accrued, unearned)
- A quick "how am I doing right now" check is harder — book profit and cash in hand can be very different
Side-by-Side Examples
| Scenario | Accrual Basis | Cash Basis |
|---|---|---|
| Sales order received in May 2024; payment received in August 2024 | Record income in May 2024 | Record income in August 2024 |
| Rent of ₹1,000 per month paid for 15 months ending June 2024 (paid in advance) | ₹12,000 expense this year (12 months consumed) | ₹15,000 expense this year (full amount paid) |
| Electricity bill of ₹5,000 received in March but paid in April | Expense in March (service used) | Expense in April (cash paid) |
Which Method Should You Use?
For most Indian businesses the answer is accrual:
- Companies registered under the Companies Act must use accrual
- GST returns are inherently accrual — output GST is reported when you raise the invoice, not when you collect
- Any business with debtors and creditors needs accrual to show its true position
Cash basis is reasonable only for very small businesses with no credit transactions — a small kirana store, a tea stall, a freelancer paid daily.
In iAccounting
iAccounting records everything on the accrual basis (because that's what GST requires) but lets you toggle to a cash-basis view on any report — useful for cash-flow planning even when your statutory books are accrual.
Try the dual-view reportsContinue Learning
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