Differences between cash and accrual basis accounting

Full Answer Section

xample of an Adjusting Entry:

Let's say a company pays its employees every two weeks. If the end of the accounting period falls in the middle of a pay period, the company has incurred employee wages for that portion of the period, even though the employees haven't been paid yet. To record this expense, the company would make the following adjusting entry:

This entry records the wages expense for the period and creates a liability (Wages Payable) to recognize the company's obligation to pay its employees for the work they've already performed.

Sample Answer

Cash Basis vs. Accrual Basis Accounting

Cash Basis Accounting

• Definition: Records revenue when cash is received and expenses when cash is paid out.  
• Example: A freelance writer receives $1,000 from a client for an article written and delivered in January. Under cash-basis accounting, the revenue is recorded in January when the payment is received, even if the article was written in December.

Accrual Basis Accounting

• Definition: Records revenue when it is earned and expenses when they are incurred, regardless of when cash is exchanged.  
• Example: A company provides a service to a client in January and bills them $5,000. Under accrual-basis accounting, the revenue is recorded in January when the service is provided, even if the client doesn't pay until February.  

Adjusting Entries in Accrual Accounting

Accrual accounting requires adjusting entries at the end of an accounting period to ensure that revenues and expenses are recorded in the correct period.

These entries account for transactions that have occurred but haven't been recorded yet due to the timing of cash flows.