The basis of accounting refers to the methodology under which revenues and expenses are recognized in the financial statements of a business. When an organization refers to the basis of accounting that it uses, three primary methodologies are most likely to be mentioned:
- Cash basis
- Accrual or mercantile basis
3. Mixed or hybrid basis.
Under cash basis of accounting, actual cash receipts and actual cash payments are recorded. In this basis, revenue is recognised when cash is received and expenses are recognised when cash is paid. Credit transactions are not recorded till cash is actually received or paid. Under this basis,
- Any income received
- Any expenditure paid
- Any asset purchased for which cash is paid
- Any liability paid during the accounting period whether related to the past, present or future is taken into account.
Accrual or mercantile basis
Under accrual basis of accounting, the revenue whether received or not, but has been earned or accrued during the accounting period and expenses incurred whether paid or not are recorded. In other words, revenue is recognised when it is earned or accrued and expenses are recognised when these are incurred. Under this basis,
- Any income earned whether received or not
- Any expenditure incurred whether paid or not
- Any asset purchased whether cash is paid or not
- Any liability incurred whether paid or not during the accounting period is recorded.
Under section 128(3) of the Indian Companies Act, 2013, all the companies are required to maintain the books of accounts according to the accrual basis of accounting.
Hybrid or mixed basis
This basis is a combination of cash basis and accrual basis of accounting. Under mixed basis of accounting, both cash basis and accrual basis are followed. Revenues and assets are generally recorded on cash basis whereas expenses and liabilities are generally taken on accrual basis.