In a cash basis system a company records revenues when cash is received and expenses when they are paid. This is in contrast to an accrual basis system, which recognizes revenue as it is earned and expenses as they are incurred. Generally, a balance sheet prepared using accrual accounting will more accurately reflect the financial position of a company, but there are occasions when a cash basis balance sheet can be useful. By making a series of adjustments to entries an accrual basis balance sheet can be converted to a cash basis balance sheet.
Eliminate accounts receivable. Accounts receivable are billings that have been earned but have not yet been paid. Accounts receivable should be credited and retained earnings debited to remove accounts receivable from the balance sheet. Any allowance for bad debts should be debited and offset with a credit to retained earnings.
Eliminate accounts payable. Accounts payable are expenses that have been incurred but have not yet been paid. Accounts payable should be debited and retained earnings credited to remove accounts payable from the balance sheet.
Eliminate asset accruals and deferrals. Asset accruals and deferrals are items that have been added to the balance sheet to account for non-cash assets. Examples of asset accruals and deferrals include unbilled revenue, accrued interest income and deferred tax benefits.
Eliminate liability accruals and deferrals. Liability accruals and deferrals are items that have been added to the balance sheet to account for non-cash liabilities. Examples of liability accruals and deferrals include deferred revenue, accrued interest payable, accrued payroll costs and deferred tax expenses.
Verify that the sum of the company’s assets is equal to the sum of the company’s liabilities plus stockholder equity. Verifying that the basic accounting equation has held is always a good idea when making a series of complex entries.
It is rare to find a company that uses a strict cash basis system. Most companies that do not prepare accrual basis statements will prepare modified cash or tax basis statements, in which inventory is carried at cost and long-lived assets are capitalized and depreciated over their useful lives. Additional entries would need to be made to eliminate inventory and long-lived assets if the user wanted a strict cash basis balance sheet.
Companies will frequently use different depreciation methods for accrual and cash basis reports. If there are differences in depreciation methods additional entries need to be made to adjust accumulated depreciation to its cash basis value.
- "Intermediate Accounting"; Jan R. Williams, et al.; 1995
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