Cash Basis Versus Accrual Basis Accounting

CAPITAL is an accrual based accounting system and expense reports are normally printed using the accrual basis, which is the default reporting option.

You can, however, if there is a requirement, generate a report on the cash basis by changing the Reporting Basis setting before running the report.

The term "accrual based accounting" means that CAPITAL recognises expenses as having been incurred at the time the expense was recorded in the system. (This usually means at the time a bill was received or a supplier invoice presented and entered into your computer.)

In cash basis accounting, an expense is not recognised until it has been fully, or at least partly, paid. Or in other words, when a payment is entered against your various outstanding invoices.

Accrual basis accounting is recommended simply because it tends to produce more meaningful accounting reports. That is, operating expenses will more closely reflect the periods in which you actually used those goods or services. This is important because managers are interested in looking at the relationship between expenses incurred versus work done/income generated, in order to determine the actual net profit margin for a set period of time.

This is much more difficult to determine using cash basis accounting because operating expenses are not reflected in your reporting until your bills are paid. This means that the expenses shown will tend to reflect when you had the money to pay your bills, rather than the relationship between the income you have generated and the overheads incurred in producing that income.

If you do need to create reports using cash as the reporting basis, then the following issues should be carefully considered:

• Under CAPITAL, expenses are always assigned against supplier invoices. Expenses are not assigned against payments, unless the expense is entered directly through the cash management system. This may occasionally lead to a small degree of unavoidable rounding error, usually in the order of a few cents, if your supplier invoices are not paid for in full. (This is because CAPITAL must divide the proportion of each payment against the invoices paid.)

When you enter an expense into one of CAPITAL's cash books, the acknowledgement of the expense (the supplier's invoice) and the payment of that expense occur simultaneously.

• The date of the payment determines when a transaction appears on a cash basis report. A cash basis report for any particular month might include paid or partly paid transactions from earlier periods as well as transactions from future periods. (Pre-payments.)

• Incurred expenses are calculated by dividing the payment amount evenly across all dissections on your supplier invoices and other transactions. Consider this example:

If you leave unallocated payments or adjustments in the period you are reporting on, you may fail to generate a cash basis report that shows a full and correct listing of your expenses and other overheads.

An Example

A payment of $200 allocates $100 of this amount to invoice 1000. The value of this invoice is $170. Invoice 1000 is assigned to two expenses, $50 to 21100 (Lease Fees) and $120 to 21500 (Rental Paid).

Proportion of payment = $100. Value of invoice = $170. Proportion of this invoice paid is 100 / 170 = 58.82%