Accounting Bases

Accounting bases refer to the principle upon which financial statements (financial reports) are prepared and presented for users' consumption. There are basically three accounting bases. These are:

 Accrual basis

Cash basis

Break-Up basis

Accrual Basis

The accrual basis comes from the accrual concept of accounting. This basis requires that transactions (incomes and expenditures) are recognized in the period that they occur but not necessarily in the period when cash is paid or received. When an entity is a going concern, its accounting reports are prepared on the going concern basis. For this, its non-current assets are valued and reported on historic basis before charging depreciation.

Example 1

The electricity bill of ₦25,367.08 for myFATutor for the month of January, 20x6 is received in the month of February, 20x6. Accrual basis requires that this bill amount be recognized in (posted to) the transactions for January, 20x6. This in effect, is to comply with the matching concept of accounting which says that revenue and expenses of the same period be matched together to determine the profit from operation. The reverse of this transaction holds true for expenses.

Cash Basis

Cash basis recognizes transactions in the period in which cash is received or paid. This means that as against the accrual basis, the cash basis only recognizes transactions in the period cash is received or cash payment is made. It does not recognize accrued expenses or accrued income. It also does not recognize future commitments in its report.

Both the accrual and cash bases assume that the reporting entity is a going concern, meaning that the entity is expected to operate in the future.

Example 2

Extract from the books of account of Solutions Plc. shows the following for the year ended 31^st December, 20x8

1.     Total cash received in respect of goods sold during the year ended 31 December, 20x8 amounted to ₦25,030,152

2.     Total cost of all supplies (goods and services) received from vendors during the year amounted to ₦16,505,080

3.      Salaries paid during the year amounted to ₦2,000,480

4.      Cash payments made to suppliers for goods supplied and services rendered in respect of year 20x8 amounted to ₦8,051,000

5.     Sales for which payment is yet to be received in respect of year 20x8 amounted to ₦4,011,210

6.     Unpaid salaries for year ended 31 December, 20x8 amounted to ₦403,156

7.     Rent expenses for the year amounts to ₦850,000

8.     Part-payment made for rent expenses for the year amounts to ₦615,000

Required

Prepare the income statement using

a.    Accrual basis

b.    Cash basis

    Suggested Solution 2

 

You may also like to read Practice Question for Readers on accounting bases

Brief explanation – Accrual Basis

1.    Total revenue refers to both cash sales and credit sales for accrual accounting; thus, both the cash and credit figures were added to get total revenue for the year.

2.    Total salaries for the year also means salaries paid and the balance remaining unpaid, i.e. both cash and credit figures.

3.    Rent expenses refers to the total rent for the year irrespective of whether or not payment was made.

4.    You will notice that item 4 was not captured in the above statement. The simple reason is that item 4 is absorbed in item 2 which is the total cost of all supplies, whether paid for or not; hence, there is no point bringing in item 4

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Brief explanation – Cash Basis

1.    All credit items are excluded as cash basis only recognizes actual cash paid or received. For this, outstanding salaries and credit sales, for which cash is yet to be received are both excluded.

2.    Rather than recognizing total cost of all supplies, i.e. Item 2, item 4 is recognized instead. This is because item 4 is the actual cash paid.

3.    For rent expenses, only the payment made is recognized (as required by cash basis)

Break up Basis

The break up basis is used when the going concern status of the reporting entity ceases to exist. If, for instance, a law court orders the liquidation of a company, the financial affairs of that company will be prepared (reported on) using break up basis. This is to show that the company has ceased to exist.

Practice Question for Readers

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