Accounting basis is the timing at which financial transactions are recorded in the books of accounts. It is also referred to as one of the methods used in recording income and expenses and the presentation of line items in the financial statements excluding statements of cash flow.
How to understand the accounting basis
In recording financial transactions, certain rules must be applied. These rules and principles are Generally Accepted Accounting Practices (GAAP). One of the GAAPs is the accounting basis. It tells you the timing at which to record business events. For example, if a company is expecting a commission for the sales of a product from a client, when is the right time to record it? Is it when the sales were made or when the commission was received in cash or kind from the client?
The basis of accounting helps to resolve it. Here, the company may need to choose what timing is appropriate in recording their transactions (in this case, commission) and this will guide how it is presented in the financial statements. Most companies follow accounting standards to do this. A popular accounting standard is the International Financial Reporting Standards (IFRS). This complies with the accrual basis of accounting.
Therefore, in the above example, the commission will be recorded based on this method. Below, we explain the accrual basis and the other two accounting bases. Note that although we use income and expenses to explain this article, this basis can be used to record other classes of accounts such as capital, liabilities, and assets.
Types of accounting basis
Accrual basis
Also referred to as the accrual concept and accrual accounting. It is the method used to record income and expenses when they occur rather than when cash is received or paid. Generally, there are two types of transactions - Cash and credit transactions. Accrual accounting focuses on credit transactions.
In our example, the company will record commission when the sales are made and not when the client pays for the commission. The accrual concept states that income is recognised when they are earned and expenses when they are incurred, and not necessarily when cash is received or paid.
Recording transactions this way results in prepayments and accruals adjustments in the book of accounts. And they are recorded in the statement of financial position.
Cash basis
Cash basis is the opposite of accrual accounting. In this case, income and expenses are recorded when cash is received or paid. The timing here is cash being received or paid. And it doesn't matter when the transaction occurs.
For example, the commission may be due in February 2025 because that is when the sales were made. But the client delayed the payment to June 2025. Using the cash basis, the company will record the transaction in June 2025. However, for accrual, it will be posted in the books in February 2025 when the event happened.
This accounting basis does not recognize prepayments and accruals in the balance sheet. Accountants apply this method when preparing statements of cash flow. It is simple to use and a non-accountant can use this method.
Break-up basis
The third basis of accounting is the break-up basis. This method records financial transactions when a business is shut down or liquidated. Here, transactions are recorded when the business is liquidated. The breakup basis uses the market value to record transactions.
During this time, financial statements cannot be prepared. Instead, a statement of affairs is presented to reflect the market value of the company at which its assets can be sold to clear off its debts and settle the business owners.
Finally, accounting basis best practices are to record transactions when they occur for accrual accounting, cash is received or paid for cash basis, and at market value for break-up basis. IFRS standards made use of the accrual concept and it is the most used method.
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