There are two main methods that businesses can use to record accounting transactions. These are the cash basis accounting and the accrual basis accounting. The cash basis accounting method uses a concept whereby the recording of cash receipts and cash payments occur during the transaction period. This method considers revenue and expenses as dependent on the reception of cash and its disbursement respectively. It fails to consider the principles of revenue recognition and matching which are crucial in accounting practices. Inconsistency in revenue recognition and matching introduces challenges in the measurement of profits. Another feature of the cash-basis accounting method is the absence of the inventory account (Kieso & Weygandt, 2010). The method ensures that goods meant for sale appear as direct costs within the period of payment. Concepts of the cash basis accounting method portray the method as an ineffective tool for measuring profits. It disregards receivables and payables, which are key elements in the profit and loss analysis.
The accrual basis accounting method recognizes revenue and expenses independently. In this regard, the handling of the reception of cash or its disbursement occurs in accounts different from those for recognizing expenses and revenue (Rich, 2012). Accrued revenue accounts and differed revenue accounts help in recording accounts receivable and unearned revenue respectively. Similarly, accrued expense accounts and deferred expense accounts help to record accounts payable and prepaid expenses respectively. Another aspect of the accrual basis accounting method is the use of the inventory account (Spiceland et al., 2004). Compared to the cash basis method, the accrual method of accounting is more expensive to implement. The cash basis method is simple to implement and effective in the presentation of cash flow. Concerning the accuracy for the measurement of profits and business performance, the accrual basis method provides a more extensive and accurate framework for such analysis (Stickney, 2010). Furthermore, the method’s compliance to revenue recognition and matching facilitates effective profit measurement.