I'm very new in accounting and currently reading about the financial statement facing a point that got me stuck.

Why is it necessary to construct financial statement on accrual basis rather then cash basis?

2 Answers 2



Accrual accounting means revenue and expenses are recognized and recorded when they occur, while cash basis accounting means these line items aren't documented until cash exchanges hands.

Cash basis accounting is easier, but accrual accounting portrays a more accurate portrait of a company's health by including accounts payable and accounts receivable.


It's not "necessary" to use accrual. It's just an option. Unless someone -- a government agency or whomever -- is telling you that you have to. In the United States, when you pay federal taxes, you can choose to do it based on cash accounting or accrual accounting. There are limits on how often you can switch. (I presume to prevent a business from figuring out each year which will result in lower taxes and switching back and forth constantly.)

To elaborate a bit on RonJohn's answer:

In cash accounting, you count a transaction when you pay or receive the money. In accrual accounting, you count a transaction when a commitment is made to pay.

So say you have $100. On February 1 you make a deal to buy a widget for $40. You tell the seller to send you a bill and then you walk out of the shop with the widget. On February 7 you get the bill and you pay it February 10.

So how much money do you have on February 2? Under cash accounting, we would say that you have $100. Because that's the amount of money that is in your pocket. when you pay the bill on February 10, now you have only $60. (Assuming no other ins or outs in the meantime.)

Under accrual account, we would say that on February 2 you have $60. You have $100 in cash minus the $40 you committed to pay.

Which is "more accurate"? That depends how you look at it. On the one hand, it would be foolish in my example for you to go out on February 3 and buy something that costs $70. When the bill comes in for the widget, you won't have the money to pay it. It is certainly wise to keep your debts in mind when considering what you can afford to buy. Likewise it is reasonable to consider what income you expect to have coming in. So in that sense, accrual is more accurate.

On the other hand, just because someone promised to pay you doesn't mean they really will. They might be scamming you and have no intention of paying. They might go broke and be unable to pay. So it can also be dangerous to rely 100% on money owed you actually coming in. Until you have the money in your hands, there's some amount of uncertainty. In that sense cash accounting is more accurate.

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