Methods of accounting refer to the techniques used by a business to record financial transactions and determine when income and expenses are recognized in the books. The two main methods are the cash basis, where transactions are recorded when cash is received or paid, and the accrual basis, where transactions are recorded when they occur, regardless of cash flow. Some businesses also follow a hybrid method combining features of both.
Accrual Basis of Accounting (Mercantile System)
In the mercantile system, transactions are recorded when they occur, regardless of whether cash is received or paid. This method matches income and expenses to the accounting period they relate to, giving a true and fair view. It is the most widely accepted and legally required method for companies and large businesses.
- Recognises income when earned, not when received.
- Records expenses when incurred, not when paid.
- Provides accurate matching of revenue and expenses.
- Required under accounting standards and company law.
Cash Basis of Accounting
The cash system records transactions only when actual cash is received or paid. It does not consider outstanding income or unpaid expenses. This method is simple to maintain and is often used by small traders or professionals.
- Income is recorded only when received.
- Expenses are recorded only when paid.
- Easy to use but may not show true profitability.
Hybrid Method (Mixed Method)
The hybrid method of accounting is a combination of the cash and accrual basis. It allows a business to record some transactions on a cash basis and others on an accrual basis, depending on what suits their needs.
- Combines the simplicity of cash basis with the accuracy of accrual basis.
- Commonly used by small and medium businesses for internal purposes.
- Not accepted under accounting standards like GAAP or IFRS, and not suitable for companies required to maintain full accrual-based books.
- Offers flexibility in recognizing income and expenses.
Cash vs. Mercantile System
| Aspect | Cash System | Mercantile System |
| Entry Basis | Cash received or paid | Transaction occurs (irrespective of cash) |
| Income Recording | On cash receipt | On earning |
| Expense Recording | On cash payment | When expense is incurred |
| Accuracy | Less accurate | More accurate |
| Complexity | Simple | Detailed and standardised |
| Legal Validity | Not suitable for companies | Legally accepted and required |