Accounting is defined as the art of recording, summarizing, reporting, and analyzing financial transactions. There are two methods or basis for the purpose of recognizing revenues and expenses while preparing financial statements of a company. One is called cash basis of accounting and other is called accrual basis of accounting
Cash Basis of Accounting:
In this approach revenue is recognized only on receipt of cash and expenses are recognized only when they are paid in cash. Hence the difference between the total income and total expense will be the profit or loss of the company during the particular period of time. The advantage of this method is its simplicity of use.
Accrual Basis of Accounting:
Under this method revenue or income is recorded in the books of account in the period in which they are earned and not at the time of receipt, also the expenses are charged to period to which they relate, whether they have been paid or not. In this method difference between total income and total expense is the profit or loss for the period. In this method adjustments are made for outstanding, prepaid accrued income and expenses. The advantage of this method is that it takes into account all adjustments and hence it presents true and fair picture about the financial position of the company.