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Bases of Accounting refer to the methods used to record financial transactions. There are two main bases: Cash Basis and Accrual Basis (also known as Mercantile Basis).
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Cash Basis of Accounting: Records only those transactions where cash is actually paid or received. Credit transactions, outstanding expenses, and prepaid items are ignored. It is generally used by Non-Profit Organizations (NPOs) for Receipt and Payment accounts.
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Advantages of Cash Basis: Simple to maintain, more objective with no need for estimations, and suitable for enterprises with mostly cash transactions.
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Disadvantages of Cash Basis: Does not provide a true and fair view of financial position, and violates the matching principle.
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Accrual Basis of Accounting: Records revenues when they are earned and expenses when they are incurred, regardless of when cash changes hands. It complies with the Revenue Recognition and Matching Principles.
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Under the Companies Act 2013, companies are mandated to use the Accrual Basis of Accounting for their financial statements.
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Advantages of Accrual Basis: More scientific method that reflects the true financial position through necessary adjustments (like prepaid/outstanding expenses and accrued income).