Let’s us first understand what these two methods mean followed by their tax implications.

What is cash accounting method?

In this method, income and expenses are recorded in accounts when they are actually debited and credited, respectively. For example, if rent is due on property on the 15th March, but is actually received on the 18th March, the transaction is recorded in the books on the 18th March.

What is accrual based method?

In this method, receipts and payments are recorded when they are accrued and not when they are actually realized. For example, if payment of electricity bill is due on the 10th March, but is actually paid on the 15th March, the entry is recorded in books of accounts is made on the 10th March itself.

When is a taxpayer liable to pay income tax in accrual and cash accounting method?

In case of cash-based accounting, tax is payable when the income is actually received and recorded. In case of accrual basis or the mercantile basis, income tax becomes payable when the receipt is due, whether it is actually received or not.

What kinds of income can cash accounting method be used for?

You can use this method only for Income from Other Sources and Profits & Gains from Business & Profession.

What kinds of income can accrual based method of accounting be used for?

This method can be used for all types of income, and mandatorily for income from house property, salary, and capital gains

What is the tax implication when income is accrued in the current financial year but received in the next one?

When income is due in March, it is recorded in the current year’s accounts for income tax purposes whether it is received in March or April or later, under accrual based method. Under the cash accounting method, the same income will be recorded for tax purposes in the next year’s accounts when it is actually credited.

What about a payment due in March which is paid in April?

This, too, will have a separate treatment under cash accounting and accrual accounting. Under the cash method, the payment will be recorded in the next financial year, i.e. April. While under the accrual method, this payment will be reflected in accounts in this year March itself.

Will cash accounting method reduce tax liability?

Not really. Cash accounting might only postpone tax payment and not actually reduce it.

Is the accrual based method ideal, then?

Not necessarily. If receipts are expected to be irregular and uncertain, the accrual method will put more significant strain on financial planning. What way is suitable depends on the type of profession/business.

Differences between Cash Basis of Accounting and Accrual Basis of Accounting
Basis Mercantile accounting Cash accounting

Meaning

Transactions in this system are noted as and when they happen. Regardless of whether they are received or accrued, revenue is recorded in the books of accounts at the time it is earned.

Payment receipts are recorded in the period in which they are received when using the cash accounting system, while expenditures are recorded in the period in which they are actually paid.

Company Act 2013

The Companies Act recognize the mercantile foundation of accounting method.

The Companies Act does not recognize the cash foundation of accounting method.

Scope

Scope of mercantile accounting is wider.

Scope of cash accounting is narrow.

Complexity

Maintaining books of accounts under mercantile is complex as compared to cash basis.

Maintaining books of accounts under cash is simple as compared to mercantile basis of accounting.

Recording

It records transaction when the revenue or expenditure is recognized.

It records transaction when the cash is received or paid.

Adjustment

Prepaid expenses, Outstanding expenses etc. are adjusted.

Prepaid expenses, Outstanding expenses etc. are not adjusted.
Conclusion

Whichever method is used for accounting, needs to be well-thought of, as it cannot be changed again and again, and the change also requires an elaborate process. Once you've decided on an accounting method, you're expected to use it regularly. If your goal is to reduce or avoid taxes, you cannot frequently change your accounting technique.