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Even though predicting future cash flows is the primary goal of many users of financial reporting,
the model best able to achieve that goal is the accrual accounting model. A competing model is
cash basis accounting. Each model produces a periodic measure of performance that could be used
by investors and creditors for predicting future cash flows. The difference between cash and
accrual accounting lies in the timing of when sales and purchases are recorded in your accounts.
Cash accounting recognizes revenue and expenses only when money changes hands, but accrual
accounting recognizes revenue when it’s earned, and expenses when they’re billed (but not paid).
In this module, we will discuss further the main differences between the two and how to convert
the cash basis to the accrual basis of accounting.

After successful completion of this module, you should be able to:

 Describe the distinction between the cash basis and the accrual basis of accounting
 Appreciate the rationale for the use of accrual basis of accounting in the preparation of the
financial statements
 Be able to prepare adjustments in converting the cash basis financial statements to accrual
basis financial statements

Methods of Accounting
Cash Basis of Accounting. Some small enterprises and the average individual taxpayer may use
a strict or modified cash-basis approach. Under the pure cash basis of accounting, revenue is
recognized when cash is received and expenses are recognized when cash is paid. The
determination of profit thus rests on the collection of revenue and the payment of expenses rather
than on the earning of revenues and the incurring of expenses. The claimed advantages of cash
basis of accounting are as follows:
(1) It is simple and less costly because transactions are recorded only when cash is received or
paid; and
(2) It does not require estimates and judgments.
Since cash basis accounting does not require adjustments at the end of a reporting period, it creates
a mismatching of revenues and expenses. It does not report receivables, payables, and deferrals.
Hence, cash-basis profit is not useful in evaluating enterprise performance because it does not
reflect the results of all profit-directed activities which took place during the period.

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Cash receipts and payments and the related accomplishments and efforts often occur in different
periods. Consequently, financial statements prepared under cash basis of accounting do not present
the financial position or performance of an enterprise in conformity with generally accepted
accounting principles.
Modified Cash Basis of Accounting. A pure cash basis of accounting is seldom found in practice,
but a modified cash basis is more common. The modified cash basis is a mixture of cash basis and
accrual basis. It is based on the strict cash basis but with modifications that have substantial
support, such as capitalizing and depreciating plant assets or recording inventory. This method is
often followed by professional services firms (doctors, lawyers, accountants, and consultants) and
by retail, real estate, and agricultural operations. The significant features of the modified cash basis
are
 Revenue is reported in the year of cash receipts;
 Expenditures having benefits of more than one year are capitalized as assets and
depreciated or amortized over their respective useful lives;
 Accrued expenses, however, are not recognized, and expenses are recorded only when paid
in subsequent period;
In any business enterprise in which purchase, production, or sale of merchandise is a significant
factor, these transactions must be reported on an accrual basis. Thus, for these enterprises, the
revenue from sales, cost of goods sold, gross profit on sales and depreciation will be the same as
they are under the accrual basis of accounting. For example, when merchandise is sold on credit,
the revenue must be recognized immediately. The cost of goods sold must reflect purchases on
credit and inventories on hand whether paid or not.
Companies in the following situations might use a cash or modified cash basis:
(1) A company that is primarily interested in cash flows (for example, a group of physicians
that distributes cash-basis earnings for salaries and bonuses).
(2) A company that has a limited number of financial statement users (small, closely held
company with little or no debt).
(3) A company that has operations that are relatively straightforward (small amounts of
inventory, long-term assets, or long-term debt).
Accrual Accounting. The accrual basis of accounting recognizes the impact of a business
transaction of an entity when the transaction occurs, whether or not cash is received or paid.
Revenues are recognized when earned and expenses are recognized when incurred, irrespective of
when cash is received or paid. Adjustments are necessary at the end of the period to update certain
assets, liabilities, revenues, and expenses. The accrual basis, therefore, presents a more complete
set of information than does the cash basis of accounting.
Conversion from Cash Basis to Accrual Basis
IAS 1 prescribes the use of the accrual basis of accounting in the preparation of an enterprise’s
financial statements. In addition, the recognition principles discussed in the Framework for the
Presentation of the Financial Statements are based strictly on the accrual basis of accounting.

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Hence, even companies that are maintaining their accounting records using the cash basis of
accounting should prepare financial statements using the accrual basis.
The conversion of cash basis information to accrual accounting focuses on the recognition of
accrual and deferrals. These are the items that are ignored under the cash basis. This conversion is
exactly the opposite of the procedures undertaken when preparing the statement of cash flows. The
summary of the calculations are as follows:
Cash Basis Adjustment Required Accrual Basis
Cash receipts from + Accounts receivable, end
customers + Sales returns, discounts,
and allowances
+ Accounts written off as
worthless
- Accounts receivable, beg
+ Customer advances, beg
- Customer advances, end = Gross credit sales

Cash received for + Unearned rent, beg

rent - Unearned rent, end
+ Rent receivable, end
- Rent receivable, beg = Rent revenue
Cash received for + Interest receivable, end
interest - Interest receivable, beg
+ Amortization of discount
on FVOCI securities
- Amortization of premium
on FVOCI securities = Interest revenue
Cash paid for + Accounts payable, end]
purchases - Accounts payable, beg] = Net purchases
+ Inventory, beg}
- Inventory, end} = Cost of goods sold

Cash paid for + Prepaid insurance, beg

insurance - Prepaid insurance, end = Insurance expense

Cash paid for + Wages payable, end

wages - Wages payable, beg = Wages expense

Cash paid for + Income tax payable, end

income tax - Income tax payable, beg
+ Deferred tax asset, beg
- Deferred tax asset, end
+ Deferred tax liability, end
- Deferred tax liability, beg = Income tax expense

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Most of the computations provided start with either cash receipt or cash payments taken from the
cash book and end with either revenue or expenses which are reported in profit or loss.
Adjustments included are both accruals (accrued revenues and accrued expenses) and deferrals
(unearned revenues and prepaid expenses).
Notice a pattern in the summary provided. When converting from cash receipts to accrual basis
income, we add ending balances of assets and deduct ending balances. This approach will result
to increases in assets being added and decreases in assets being deducted to/from the cash receipts.
For example, an increase in accounts receivable means that the company earned more revenue than
cash collected, requiring the addition to cash basis figure. On the other hand, we add beginning
balances of liabilities and deduct ending balances. This is done so that increases in liabilities are
deducted and decreases in liabilities are added to/from cash receipts. For example, a decrease in
interest payable means that the company incurred less interest expense than the cash interest it
paid, requiring the addition to cash basis figure. These adjustments are summarized below:
Cash receipts XX
+ Asset, end XX  are added
- Asset, beg XX ↓ are deducted
+ Liability, beg XX
 are deducted
- Liability, end XX
↓ are added
Accrual Income XX
Conversely, the following pattern can be observed when converting from cash payments to accrual
basis expenses:
Cash payments XX
+ Liability, end XX  are added
- Liability, beg XX ↓ are deducted
+ Asset, beg XX  are deducted
- Asset, end XX ↓ are added
Accrual Expense XX
Note: You may also use the T-account approach to in converting the cash basis to accrual basis.

PROBLEMS
Problem 1. For each of the following independent items, make the required calculations:
a. Prepaid insurance, beginning P
Prepaid insurance, ending 13, 480
Insurance expense for the year 38,900
Insurance premium paid for the period 48,200

b. Sales revenue P
Cash, beg 700,000
Cash, end 980,000

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 Total cash disbursed during the period 1,160,000
All cash receipts were from customers
Accounts receivable, beg 1,200,000
Accounts receivable, end 1,660,000
Accounts written off during the period 30,000

c. Depreciation expense P
Equipment (net), beg 210,000
Cost of equipment acquired during the year 80,000
Equipment (net), end 206,000
Equipment with an original cost of P60,000
was sold at a loss of P4,000 during the period 36,000

d. Collections of rent P
Rent collected in advanced, beg 80,000
Rent collected in advanced, end 100,000
Rent earned but not yet collected, beg 54,000
Rent earned but not yet collected, end 30,000
Rent earned during the period 440,000

Problem 2. The following data were taken from the incomplete accounting records maintained by
Grain Company, a sole proprietorship:
Dec. 31, 2020 Dec. 31, 2019
Cash P 45,600 P 67,900
Accounts receivable 59,400 76,100
Merchandise inventory 97,200 105,800
Prepaid expenses 6,000 7,500
Equipment (net) 85,000 95,500
Accounts payable 63,300 69,900
Loans payable to the bank 50,000 40,000
Accrued expenses 4,500 5,600
Transactions per cash book during 2020:
Receipts:
From customers P697,500
From bank loan 40,000
Rent income 8,000

Payments:
To trade creditors 536,600
For operating expenses 94,100
Purchase of equipment 20,000
Withdrawals by the owner 20,000
Loan payable to the bank 52,500

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Other information:
a. Sales returns during the year were P21,000. Bad debs written off directly against accounts
receivable were P10,800.
b. Purchase returns during the year amounted to P13,000. Goods received from supplier on
account on December 20, 2020 costing P8,000 were not recorded by the company until
January 2021.
c. The only change in the equipment is the purchase of new computer on June 30, 2020.
Depreciation charges are credited to the long-lived assets account from the month
following the purchase.
Required: Determine the accrual basis balance of following:
(1) Gross sales
(2) Gross purchases
(3) Operating expenses
(4) Depreciation expense
(5) Net income (loss) for the period

MULTIPLE CHOICE QUESTIONS

MC1 Under the accrual basis, revenues are recognized when they are
a. Collected
b. Earned
c. Earned and collected
d. Earned and become measurable
MC2 Under the cash basis, revenues are recognized when they are
a. Collected
b. Earned
c. Earned and collected
d. Earned and become measurable
MC3 The recognition of expenses under accrual accounting, is based on three principles: direct
matching, systematic and rational allocation and immediate recognition. The direct
matching principle requires that expenses be recognized
a. When they are paid by the enterprise
b. In the same period that the costs expire or assets are used
c. In the same period in which revenues are recognized that the expenses help to
produce
d. In the same period that the revenue is received that the expenses help to produce
MC4 Under the cash basis, expenses are recognized when
a. They are paid by the entity
b. The costs expire or assets are used
c. The revenues are recognized that the expenses help to produce
d. Cash is received from revenues that the expenses help to produce
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MC5 A company’s merchandise inventory increased during the period, while its accounts
payable decreased during the period. how would these increases or decreases be added to
or deducted from cash payment to merchandise supplier to arrive at accrual basis cost of
goods sold
Increase in inventory Decrease in accounts payable
a. Added Deducted
b. Added Added
c. Deducted Deducted
d. Deducted Added

MC6 When converting from cash to accrual basis of accounting, which of the following
adjustments should be made to cash collections from customers to arrive at accrual basis
sales?
a. Add ending accounts receivable
b. Subtract ending accounts receivable
c. Add beginning accounts receivable
d. Deduct beginning balance of advances from customers
MC7 When converting from cash to accrual basis of accounting, which of the following
adjustments should be made to cash collections from customers to arrive at accrual basis
sales?
a. Add beginning prepaid expenses
b. Subtract beginning prepaid expenses
c. Add beginning accrued expenses
d. Add ending prepaid expenses
MC8 Over the life of the enterprise,
a. Total profit using the accrual basis would be more than total profit using the cash
basis
b. Total profit using the accrual basis would be less than total profit using the cash
basis
c. Total profit using the accrual basis would equal total profit using the cash basis
d. Total profit using the accrual basis would either be more than or less than total
profit using the cash basis
MC9 Ensure Company maintains a medical and dental clinic and keeps limited accounting
records. Its assets and liabilities at the beginning and end of the current year are as follows:
Beginning End
Cash in bank P 12,000 P (5,000)
Accounts receivable 68,000 70,000
Medical supplies 30,000 15,000
Accounts payable 40,000 20,000
Notes payable – bank 20,000 25,000
Medical equipment (net) 150,000 125,000

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 During the year, the owner withdrew cash of P12,000 and made additional investment of
P50,000. The profit (loss) of Ensure Company for the year is
a. P8,000
b. P(2,000)
c. P(68,000)
d. P(78,000)
MC10 The following information pertains to Birch Tree Company’s 2020 sales:
Cash Sales
Gross P80,000
Returns and Allowances 4,000
Credit Sales
Gross P120,000
Discounts 6,000
On January 1, 2020, customers owed Birch Tree P40,000. On December 31, 2020,
customers owed Birch Tree P30,000. Birch Tree uses the direct write off method for bad
debts. No bad debts were recorded in 2020.
Under the cash basis, the net revenue to be reported for 2020 is
a. P200,000
b. P190,000
c. P170,000
d. P76,000
MC11 Bear Brand, Inc. owns an office building and leases the offices under a one-year rental
agreement. Not all tenants make timely payments on their rent. Bear Brand’s statement of
financial position contained the following data:
2019 2020
Rentals receivable P96,000 P124,000
Unearned rentals 320,000 240,000
During 2020, Bear Brand received P800,000 cash from tenants. The amount of rental
revenue for 2020 is:
a. P692,000
b. P748,000
c. P852,000
d. P908,000
MC12 The accrual profit or loss of Carnation, Inc. included the following expenses for 2020:
Depreciation expense – P65,000; Salaries and wages – P189,000; Interest expense –
P36,000.
The comparative statements of financial position reported the following related accounts:
12/31/20 12/31/19
Accumulated deprecation P96,000 P154,000

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 Accrued salaries and wages 8,000 12,000
Accrued interest payable 10,500 7,000
Considering only the data above, a pure cash basis income statement would report expenses
for 2020 of
a. P224,500
b. P225,500
c. P231,500
d. P243,500
MC13 The following data relate to store equipment of Progress Company for 2020:
2019 2020
Store equipment P145,000 P175,000
Accumulated depreciation 58,000 60,000
Store equipment costing P30,000 was sold for P21,000, resulting in a gain of P3,000.
The depreciation expense on store equipment for 2020 is:
a. P14,000
b. P11,000
c. P10,000
d. P8,000
MC14 Milkmaid, Inc. maintains its accounting records on the cash basis but restates its financial
statements to the accrual method of accounting. Milkmaid had P600,000 cash basis pretax
income for 2020.
The following information pertains to Milkmaid for the years ended December 31, 2020
and 2019:
2020 2019
Accounts receivable P400,000 P200,000
Accounts payable 150,000 300,000
Under the accrual method, Milkmaid should report in its December 31, 2020 profit or loss
a pretax profit of
a. P250,000
b. P550,000
c. P650,000
d. P950,000
MC15 The results of the current year’s operations of Cerelac, Inc. are as follows:
December 31 January 1
Accounts receivable P51,000 P45,000
Accounts payable 60,000 33,000
Accrued wages - 7,000
Collections from customers 794,000
Total cash payments 715,000

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 Selling expenses of P144,00 are 45% of gross profit. Administrative expenses are 15% of sales.
This amount includes depreciation which is 20% of administrative expenses. There are no
unpaid selling and administrative expenses as of December 31. Inventory per physical count
at year-end totaled P125,000.
Total sales for the period is
a. P705,000
b. P725,000
c. P788,000
d. P800,000
MC16 Use the same information given in MC 15. Total purchases for the period is
a. P495,000
b. P496,440
c. P499,200
d. P504,600
MC17 Use the same information given in MC 15. Total cost of goods sold for the period is
a. P480,000
b. P468,000
c. P445,000
d. P400,000
MC18 The following changes in Alaska Company’s account balances occurred during 2020:
Increase
Assets P890,000
Liabilities 270,000
Share capital 600,000
Share premium 60,000
Except for a P130,000 dividend payments and the year’s earnings, there were no changes in
retained earnings for 2020.
What was Alaska’s profit for 2020?
a. P40,000
b. P90,000
c. P130,000
d. P170,000
MC19 Following are the data relating to the operations of Centrum Company for six months
which started on July 1, 2020:
Cash receipts:
Investment by owner P250,000
Collections on sales on account 310,000
Cash sales 85,000
Proceeds of a note payable dated October 1, 2020
and due on October 1, 2021, discounted at 18% 24,600

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 Cash disbursements:
Purchase of land and building on July 1, 2020 P240,000
20% down payment on furniture and fixtures
purchased on installment on July 1, 2020 4,000
On accounts payable 280,000
For other operating expenses 45,000
Of the sales on account, P4,000 was returned because of poor quality and there was a
purchase return of P5,000. On December 31, 2020, the following balances were available:
Accounts receivable, P66,000; Accounts payable, P67,000; Accrued other operating
expenses, P3,500.
The land has an allocated cost of P40,000. Annual depreciation is 4% on the building and
10% on the furniture and fixtures.
Inventory on December 31, 2020 is P21,700.
Gross sales for the period amounted to
a. P376,000
b. P380,000
c. P461,000
d. P465,000
MC20 Use the same information given in MC 19. Gross purchases for the period amounted to
a. P347,000
b. P352,000
c. P377,000
d. P382,000
MC21 Use the same information given in MC 19. Cost of sales for the period is
a. P355,300
b. P350,300
c. P325,300
d. P320,300
MC22 Use the same information given in MC 19. Total operating expenses for the period is
a. P46,500
b. P48,500
c. P53,500
d. P58,500
MC23 Neslac, Inc. owns an office building and leases offices under a one-year rental agreement.
Not all tenants make timely payments of their rent. During 2020, Neslac received P800,000
cash from tenants. The company’s statement of financial position at December 31, 2020
and the statement of comprehensive income for the year ended December 31, 2020 reported
rent receivable and rent revenue of P124,000 and P908,000, respectively.
How much was Neslac, Inc.’s unearned rent revenue at December 31, 2020?
a. P112,000

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 b. P168,000
c. P240,000
d. P908,000
MC24 Nido Corporation provided you with the following summary of total assets and liabilities
at January 1, 2020 and at December 31, 2020:
Assets Liabilities
January 1, 2020 P9,000,000 P3,200,000
December 31, 2020 12,000,000 4,500,000
During 2020, Nido issued 10,000 shares of its P100 par ordinary share at p150 per share
and declared dividends of P280,000. There were no other changes affecting the equity
accounts.
The profit for 2012 is
a. P80,000
b. P420,000
c. P480,000
d. P980,000
MC25 Maxwell Company’s total equity increased by P320,000 during 2020. New shareholder
investment during the year totaled P650,000. Total revenues during the year were
P5,000,000 and total expenses were P4,600,000. Cash increased by P75,000 during the
year.
What amount of dividends did Maxwell Company declare during 2020?
a. P330,000
b. P655,000
c. P730,000
d. P737,500

Books:
Robles, Nenita S. and Empleo, Patricia M. Intermediate Accounting Volume 3 (2012 Edition).
Millennium Books, Inc.: Mandaluyong City.
Kieso, Donald E., Weygandt, Jerry J., Warfield, Terry D. Intermediate Accounting (14th Edition).
John Wiley & Sons, Inc.
Spiceland, J. David, Sepe, James F., Nelson, Mark W. Intermediate Accounting (7th Edition).
McGraw-Hill: Irwin.
Electronic Sources:
[Cover] https://www.freepik.com/free-photo/office-with-documents-money-
accounts_9183790.htm
https://bench.co/blog/accounting/cash-vs-accrual-accounting/

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