What is the difference between cash basis and accrual basis accounting, and why do companies use accrual?

What the interviewer wants to hear

• Cash basis records when money moves
• Accrual basis records when revenue is earned and expenses are incurred
• Accrual matches expenses with the revenue of the period
• Required for companies under Ind AS, IFRS and the Companies Act
• Gives an example of an accrual or prepayment

Model answer

Under the cash basis, you record income when cash comes in and expenses when cash goes out. Under the accrual basis, you record revenue when it is earned and expenses when they are incurred, no matter when cash moves. For example, March electricity paid in April is still a March expense, so at 31 March we book an accrued expense. Similarly, a year of insurance paid in advance is spread over the months it covers, with the unused part shown as a prepayment. Companies use accrual because it matches costs with the revenue they help earn, so profit for a period is meaningful and comparable. It is also required: the Companies Act in India requires accrual-based books, and Ind AS and IFRS are built on it. Cash flow is then shown separately in the cash flow statement.

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