Key Points
- Cash basis accounting records transactions only when cash changes hands, ignoring receivables and payables entirely.
- IAS 1.27 requires the accrual basis for all financial statements except the statement of cash flows.
- Small entities below statutory audit thresholds sometimes use cash basis for internal management or tax reporting, then convert to accrual basis at year end.
- Failing to reverse from cash basis to accrual at the reporting date misstates both revenue and liabilities, creating potential audit adjustments.
What is Cash Basis Accounting?
Under cash basis accounting, the entity records income when it hits the bank account and records expenditure when payment leaves. No receivable, no payable, no accrual. The method is simple to operate and gives a real-time view of liquidity, which is why owner-managed businesses across Europe often run their day-to-day bookkeeping this way.
The problem starts at the reporting date. IAS 1.27 mandates the accrual basis for every line item in the financial statements except the statement of cash flows, which by definition already reports cash movements. National frameworks reinforce this: HGB Section 252(1)(5) requires accrual-based recognition for German statutory accounts, and RJ 115.107 does the same under Dutch GAAP. An entity that prepares its general-purpose financial statements on a pure cash basis does not comply with any of these frameworks.
In practice, the audit risk is not that the entity claims to use cash basis. The risk is that the entity runs cash-basis bookkeeping all year and performs an incomplete conversion to accrual at period end. ISA 500.7 requires the auditor to obtain sufficient appropriate audit evidence for each material assertion. When the underlying records are cash-based, the auditor must verify that every accrual adjustment (trade receivables, trade payables, prepayments, deferred income) is complete and accurately measured.
Worked example
Client: Austrian retail company, FY2025, revenue EUR 12M, local GAAP (Austrian UGB) reporter. Kellner's bookkeeper records all transactions on a cash basis during the year. At year end, the engagement team verifies the conversion to accrual-based financial statements.
Step 1 — Identify material cash-to-accrual adjustments
The team requests a schedule of year-end conversion entries. Kellner's bookkeeper has posted four categories of adjustment: trade receivables (EUR 840,000 for December sales invoiced but not yet collected), trade payables (EUR 620,000 for goods received in December but paid in January), prepaid rent (EUR 36,000 covering January 2026), and accrued wages (EUR 95,000 for the final week of December, paid on 3 January 2026).
Documentation note: obtain the conversion schedule from the bookkeeper. Record each adjustment category, the amount, and the supporting source document (sales invoices, supplier invoices, rental agreement, payroll run). Cross-reference to the trial balance to confirm the adjustments are reflected in the final balances.
Step 2 — Test completeness of revenue accrual
The team selects all sales invoices dated December 2025 where cash was received after 31 December. Total: EUR 840,000 across 47 invoices. The team traces a sample of 15 invoices to the despatch records and customer order confirmations. All 15 relate to goods delivered before year end.
Documentation note: record the population (47 invoices, EUR 840,000), the sample size (15 invoices, EUR 412,000), the selection method, and the results. Conclude on the completeness and existence of the receivable accrual under ISA 500.7.
Step 3 — Test completeness of expense accruals
The team reviews supplier invoices dated in January 2026 with delivery dates on or before 31 December 2025. This post-year-end search identifies two invoices totalling EUR 48,000 that the bookkeeper had missed in the conversion. The team proposes an adjustment to increase trade payables and cost of goods sold by EUR 48,000.
Documentation note: record the post-year-end search procedure, the cut-off date applied, the two missed invoices (supplier names, amounts, delivery dates), and the proposed adjustment. Reference ISA 500.7 and ISA 330.20 for the substantive procedure requirement.
Step 4 — Evaluate net effect
Before the proposed adjustment, Kellner's profit before tax was EUR 310,000. The EUR 48,000 adjustment reduces it to EUR 262,000. Overall materiality for the engagement is EUR 60,000 (0.5% of revenue). The missed accrual of EUR 48,000 falls below overall materiality but above clearly trivial (EUR 3,000). The team records it on the summary of unadjusted differences and discusses it with management, who agree to post the adjustment.
Documentation note: record the impact on profit, the comparison to overall materiality and clearly trivial, management's decision to adjust, and the final adjusted trial balance.
Conclusion: Kellner's cash-to-accrual conversion is now complete after one adjustment of EUR 48,000, and the financial statements comply with Austrian UGB accrual requirements because all material receivables, payables, prepayments, and accruals are reflected at the reporting date.
Why it matters in practice
- Teams often accept the client's year-end conversion schedule without performing a post-year-end search for unrecorded liabilities. When the bookkeeping is cash-based all year, the risk that payables are incomplete is higher than for entities that record obligations as they arise. ISA 500.7 requires audit evidence for each assertion, and completeness of liabilities is the assertion most at risk in a cash-to-accrual conversion.
- Auditors sometimes overlook the revenue side of the conversion. Cash-basis bookkeeping understates revenue at year end (goods delivered, invoice sent, cash not yet received) just as readily as it understates payables. ISA 330.20 requires substantive procedures for each material class of transactions, and revenue cut-off testing must cover the receivable accrual, not only the payable accrual.
Cash basis vs. accrual accounting
| Dimension | Cash basis | Accrual basis |
|---|---|---|
| Recognition trigger | Cash received or paid | Transaction occurs (delivery, service rendered, obligation incurred) |
| Receivables and payables | Not recorded until cash moves | Recorded when the obligation or right arises |
| IFRS / national GAAP compliance | Not permitted for general-purpose financial statements | Required by IAS 1.27, HGB, Austrian UGB, RJ |
| Audit risk profile | Higher completeness risk at year end because conversion adjustments may be missed | Lower conversion risk, but cut-off and measurement risks remain |
| Typical users | Owner-managed businesses for day-to-day bookkeeping, tax filers in certain jurisdictions | All entities preparing statutory financial statements |
The distinction matters on every engagement where the client runs cash-basis books internally. If the auditor does not verify that the year-end conversion captured all material accruals, the financial statements will understate both assets (receivables) and liabilities (payables). The misstatement can go in either direction depending on whether outstanding receivables or outstanding payables are larger.
Related terms
Frequently asked questions
Can a company use cash basis accounting under IFRS?
No. IAS 1.27 requires entities to prepare financial statements on the accrual basis (except the statement of cash flows). An entity may use cash-basis bookkeeping internally during the year, but the published financial statements must reflect accrual-based recognition. The same requirement applies under HGB, Austrian UGB, and Dutch GAAP (RJ).
How do I audit a client that keeps books on a cash basis?
Focus the year-end work on the completeness of the cash-to-accrual conversion. ISA 500.7 requires sufficient appropriate evidence for each material assertion. Test receivables by tracing post-year-end cash receipts to December invoices. Test payables through a post-year-end search of supplier invoices with pre-year-end delivery dates. Document the conversion entries and the evidence supporting each one.
When is cash basis accounting actually acceptable?
Cash basis is acceptable for internal management reporting, certain tax filings in jurisdictions that permit it (such as small businesses below turnover thresholds in Austria and Germany), and entities not required to prepare general-purpose financial statements. It is never acceptable for statutory financial statements under IFRS, HGB, or Austrian UGB. If the entity must produce audited financial statements, the accrual basis applies.