One question separates them: when do we record?
Under the cash basis, revenue is recorded when cash is received, and an expense is recorded when it is paid. Under the accrual basis, revenue is recorded when it is earned by delivering the goods or service, and an expense is recorded in the period in which its benefit was received, regardless of when payment is made.
The cash basis is easy and resembles following a bank statement, but it confuses the timing of cash with the result of operations. The accrual basis links revenue to the expenses that helped generate it, which is known as the matching principle.
Example: a maintenance company in December
An air-conditioning maintenance company; these are its figures for December (before VAT):
- It carried out maintenance contracts in December and issued invoices for 100,000 SAR, to be collected in January.
- In December it collected 40,000 SAR from a customer for work done in November.
- It paid December salaries of 30,000 SAR.
- It used 3,000 SAR of electricity in December and will pay the bill in January.
- In December it paid 12,000 SAR for vehicle insurance covering the whole of next year.
| Item | Cash basis | Accrual basis |
|---|---|---|
| Revenue | 40,000 | 100,000 |
| Salaries | (30,000) | (30,000) |
| Electricity | 0 | (3,000) |
| Insurance | (12,000) | 0 |
| December result | (2,000) loss | 67,000 profit |
The same month and the same work, yet the difference in the result is 69,000 SAR.
Why did the result differ?
- Revenue: the cash basis recorded 40,000 relating to November and ignored 100,000 actually earned in December. Under the accrual basis, 100,000 appears as revenue against a debit balance in accounts receivable.
- Electricity: it was used in December, so it is a December expense even if paid later, and an accrued expense is recognized against it.
- Insurance: it serves next year, so it is recorded as an asset called “prepaid expense”, and 1,000 SAR of it is charged to expense each month from January.
Adjusting entries at the end of December under the accrual basis:
| Entry | Debit | Credit | Amount |
|---|---|---|---|
| Recognizing accrued electricity | Electricity expense | Accrued expenses | 3,000 |
| Deferring the insurance | Prepaid insurance | Bank | 12,000 |
Which one is used in Saudi Arabia?
Financial statements prepared under the International Financial Reporting Standards endorsed in the Kingdom, including the standard for small and medium-sized entities, are prepared on the accrual basis, except for the statement of cash flows, which by its nature presents cash movements. These are the statements uploaded to the Qawaem platform and on which the Zakat return is based.
Likewise, VAT usually does not wait for collection; the tax becomes due on the date of supply, the date the invoice is issued, or the date payment is received, whichever is earliest. So the company in our example declares the VAT on the 100,000 in the December period even if it has not collected it yet.
The cash basis still has a useful management role: monitoring day-to-day liquidity, preparing cash budgets, and making sure the business can pay salaries and suppliers.
Practical tips
- Prepare a monthly schedule of recurring accrued expenses (electricity, telecommunications, commissions) so you do not forget them at closing.
- Give every prepaid expense an amortization schedule showing the monthly amount and the remaining balance.
- Do not judge the month's performance from the bank balance; review the income statement and the statement of cash flows together.
How the two bases affect the owner's decisions
Let us go back to the maintenance company. If the owner relied on the cash basis, he would think December was a loss-making month, and might decide to cut technicians or turn down new contracts. In fact, December was one of the best months of the year; the only problem was the timing of collections.
The reverse also happens. Imagine the company collected 100,000 SAR in January for December's work, and carried out only 30,000 SAR of work in January. The cash basis would show January as an excellent month, while actual activity dropped sharply. An owner who decides to increase spending on that basis will discover the truth too late.
That is why the owner needs both pictures:
- An accrual-basis income statement to assess real performance, pricing, commissions and team bonuses.
- A cash flow report to manage liquidity and know when short-term financing will be needed.
The bridge between the two pictures is monitoring the balances of accounts receivable, accrued expenses and prepaid expenses. If the receivables balance rises from month to month, profit is running ahead of cash, and the owner should expect pressure on liquidity even if the results are excellent.