Accrual basis
Also written Accrual accounting
The accounting rule under which income is recorded when it is earned and expenses when they are incurred, regardless of when the cash actually moves.
In plain language
A sale counts as revenue the moment it happens. It does not matter if the customer pays today or in ninety days.
This is why the profit and loss account can show a healthy profit while the bank balance barely moves. Profit and cash are two different things, and accrual accounting is the reason.
How it works
The workbook's own illustration makes the gap concrete. A business buys goods for cash and sells them for cash: purchase Rs 80,000, sale Rs 1,00,000, profit Rs 20,000 — and the business genuinely holds that cash.
Now change one thing: the purchase is still for cash, but the sale is on credit. The profit and loss account still shows Rs 20,000 of profit, booked the moment the sale is made. But no cash has come in. If the customer never pays, the business has not just lost the Rs 20,000 of profit — it has lost the entire Rs 80,000 of capital that bought the goods in the first place.
This is exactly why the balance sheet and profit and loss account, both prepared on accrual basis, are not enough on their own. A separate cash flow statement is required to show what actually happened to cash.
A worked example
Ramesh runs a small textile trading business. In March, he buys a batch of fabric for cash, Rs 80,000, and sells the entire batch to a garment exporter for Rs 1,00,000 on 60 days' credit.
His March profit and loss account shows a profit of Rs 20,000 — the sale is booked the day it happens, on accrual basis.
But in March, Ramesh has not collected a single rupee from the exporter. His cash balance has actually gone down by Rs 80,000, the amount he paid out for the fabric. If the exporter runs into trouble and cannot pay within the 60 days, Ramesh is not looking at a lost profit of Rs 20,000 — he is looking at a lost Rs 80,000 of working capital, with a "profit" on paper that never turned into money.
Why NISM asks about it
Chapter 8.6 (Basics of Cash Flows) uses accrual basis to explain why a cash flow statement is needed alongside the profit and loss account and balance sheet. Expect a question that gives a cash-versus-credit sales scenario and asks you to separate reported profit from actual cash generated — the exact test the workbook's own example sets up.
Common exam traps
- Accrual basis is not fraud and not an accounting trick. It is the standard, required basis for the P&L and balance sheet under IndAS. The trap is treating "profit" on an accrual basis as if it were cash in hand.
- A profitable, growing company can still run out of cash if its customers are slow to pay — this is precisely why analysts read the cash flow statement alongside the P&L, not instead of it.
- Do not assume expenses follow cash either: an expense is recognised when incurred, not when it is actually paid.
Check yourself
1.A business makes cash purchases of ₹80,000 and sells the goods for ₹1,00,000 entirely on credit. What does the workbook say about this situation?
- a)The P&L shows ₹20,000 profit but there is no money; if the dues are not collected, even the ₹80,000 of capital is likely to be lost
- b)No profit can be recognised until the cash is received
- c)The ₹20,000 is recorded as a contingent asset in the notes
- d)Cash flow and profit are identical because the transaction is complete
Show the answer
Answer: (a) The P&L shows ₹20,000 profit but there is no money; if the dues are not collected, even the ₹80,000 of capital is likely to be lost
This is the workbook's own illustration of why the cash flow statement exists. Accounting is on an accrual basis — income is recognised when earned, not when received. So the P&L shows a profit of ₹20,000, and the business has no money. If the customer never pays, there is no profit and even the capital of ₹80,000 is likely to be lost.
Option B is the intuitive but wrong answer — it describes a cash basis of accounting, which Indian companies do not use for the P&L. Option C invents a treatment. Option D is exactly the mistake the whole section warns against: in absence of cash, while there may be profits, they would be more paper profits and not the real profits.
Where this is taught
Free preparation for NISM Series XVRelated terms
- Consolidated financial statementA single set of financial statements combining a parent company with every subsidiary it controls, so a group's true scale of business is not hidden inside a stand-alone filing.
- Core working capitalInventory plus trade receivables minus trade payables — the money permanently trapped in the operating cycle, stripped of cash and borrowings, which have nothing to do with trading.
- EBITDAProfit from running the business, measured before interest, tax, depreciation and amortisation — so before how the company is funded and how it accounts for its assets.
- Deferred revenueA liability representing the value of a future obligation owed for revenue already collected in advance — money received but not yet earned.