CHAPTER 6 Statement of profit or loss and statement of changes in equity 221Accrual accounting versus cash accounting
Accounting standards require that financial statements are prepared on the basis of accrual accounting, as
distinct from cash accounting. Accrual accounting is a system in which transactions are recorded in the
period to which they relate, rather than in the period the entity receives or pays the cash related to the trans-
action. This means that the reported profit or loss based on the accrual system is the difference between
income and expenses for the period. This is not synonymous with cash. A cash accounting system, in con-
trast, would determine cash profit or loss as the difference between the cash received in relation to income
items and the cash paid for expenses for the period. Under an accrual basis of accounting, the entity does
not have to receive cash associated with a transaction for that transaction to be regarded as income, so cash
received in the reporting period may not result in income being recognised. Similarly, the entity does not
have to pay cash for that transaction to be regarded as an expense, so cash paid in the reporting period may
not result in the recognition of an expense. Accrual accounting involves recognising the income and expense
transactions when they occur, not when cash is paid or received.
The purpose of accrual accounting is to better reflect the performance of the entity for a reporting period.
The timing of cash payments and cash receipts has the potential to distort performance in a period if
a cash basis of accounting is used to measure financial performance. Therefore, an entity required to
comply with accounting standards must prepare its financial statements on an accrual basis. Entities not
required to comply with accounting standards, such as many small businesses, may prepare their finan-
cial statements on a cash basis.
We will be formally defining and examining the income and expense elements later in the chapter. In
the meantime, to illustrate the concept of accrual accounting versus cash accounting, consider illustrative
examples 6.2 to 6.5 relating to Advantage Tennis Coaching (ATC). ATC’s business transactions for
September 2016 were recorded in the accounting worksheet in illustrative examples 4.1 to 4.3 in
chapter 4. The transactions described below relate to the reporting period ended December 2016.
ILLUSTRATIVE EXAMPLE 6.2Recognising income without receiving cash (accrued income)
Advantage Tennis Coaching (ATC) conducted a holiday clinic for a tennis club on 20 December 2016. The club
was invoiced $8000 for the coaching clinic by ATC, but as at 31 December 2016 (the end of the reporting
period) the invoice had not been paid. In recording the transaction in ATC’s accounting worksheet, the asset
account, accounts receivable (i.e. debtors), would be increased by $8000 and income (coaching fees) in the
profit or loss column would be increased by $8000, thereby increasing profit and hence equity. It is appropriate
to recognise the $8000 in the accounts as income in December, because ATC conducted the clinic and ren-
dered the services in December. The income has been earned even though it has not been received in cash
— it is accrued income. Accrued income is income that has been earned but not received in cash. The club
will not pay the invoice until January 2017. If ATC was operating a cash accounting system, there would be no
transaction recorded in December 2016. No income would be recognised in ATC’s accounts in relation to this
invoice for the month ended 31 December 2016, because no cash has been received for the services rendered.
Under a cash system, the income will be recognised in January 2017 when ATC receives the $8000 cash from
the club. In January 2017, the entry in the accounting worksheet under a cash system would be to increase an
asset (cash) by $8000 and increase income (coaching fees) in the profit or loss column by $8000.ILLUSTRATIVE EXAMPLE 6.3Receiving cash but not recognising income (income received in advance)
Advantage Tennis Coaching (ATC) is commissioned in December 2016 by Tennis Australia to conduct
a four-week intensive training squad for elite players to take place in January 2017. Tennis Australia
paid ATC an up-front payment of $12 000, which is banked by ATC. The transaction recorded by ATC
is to increase an asset account (cash) and increase an income account (coaching fees). However, as at