The cash-basis method of accounting accounts for transactions in which cash is exchanged. When cash is received, a cash receipt is recorded; when cash is disbursed or paid, a cash payment is recorded. The use of cash basis is common among entities that do most of their business in cash. The Internal Revenue Service allows the cash-basis method for accounting. In the United States, generally accepted accounting principles, or GAAP, discourage the use of this method for internal accounting and external financial reporting purposes, because revenues are not recorded when earned, nor are expenses when they are due.
Cash receipts are received from a variety of sources. Examples of transactions that generate cash receipts include sale of inventory, sale of services, sale of fixed assets or equipment, interest received from investments, cash dividends from stock investments and sale of company stock.
When cash receipts are received, the cash account is debited, or increased, for the amount of the cash receipt. A corresponding credit is made to a revenue account (such as for sales revenue), a liability account (unearned revenue), an equity account (common stock) or another asset (equipment).
Cash disbursements or payments are made for a variety of reasons. Examples of transactions that generate cash payments include those involving payment of liabilities, assets, prepaid expenses, debt and equity investments, treasury stock (repurchase of the company’s own stock) and current period expenses.
When cash disbursements or payments are made, the cash account is credited, or decreased, for the amount of the cash payment. A corresponding debit is made to a liability account (such as accounts payable), an asset account (inventory), a prepaid expense (prepaid insurance) or a current period expense (salary expense).
