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Cash Accounting vs Accrual Accounting

See Also:
Accrual Based Accounting
Generally Accepted Accounting Principles (GAAP)

Cash Accounting vs Accrual Accounting

There are two different types of accounting that businesses use: cash accounting vs accrual accounting. Most businesses use accrual accounting, but it varies by the type of business. These two methods are both legal and accepted by the Internal Revenue Service. The primary difference between the two is when income and expenses are recorded in the books. When thinking about cash basis accounting, picture a lemonade stand. When thinking about accrual basis accounting, imagine a grocery store.

Define Cash Basis Accounting

Cash accounting is simply recording transactions in the books when money changes hands. This excludes accounts payable, accounts receivable, and anything that has not caused a monetary transaction. A lemonade stand would use cash accounting because of its simplicity. The books of a small juice stand would not reflect payables on credit from suppliers. It would not show an anticipated receivable from customers. Another example of a cash accounting business might be a consultant. By deciding the most tax-friendly times for payments and expenses during the year, a consultant can minimize taxes due. This is not tax invasion; it is just deciding when he or she will collect payments for his or her services.

Some argue that this method fails to adhere to the matching principle. In cash accounting, revenues and expenses from the same period are not recorded as accurately. For example, if you sell 100,000 widgets in December but receive payment in January, cash basis accounting will recognize that revenue in January—the next accounting year. This can have unwanted effects on how much taxes are due.

Define Accrual Basis Accounting

Accrual basis accounting is the widely-accepted method for most businesses. In fact, some businesses require that they use accrual basis, depending on the amount of sales. When they are made, accrual basis accounting records transactions. Record sales before the money enters the company even if it sold the product or service on credit. It also means to record expenses as they are accrued.

Here’s another example to exemplify the difference: a company decides to purchase all new inventory. The entire purchase is realized even if it is not paid for yet. Think of the implications of this at the end of a year. A company could make a large purchase at the end of the year to minimize the taxes due for that period. This will increase revenue, and therefore taxes, for the following year. This example shows it is possible to distort the matching of income and expenses using accrual basis as well as cash basis accounting.

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Cash Accounting vs. Accrual Accounting, Accrual Basis Accounting

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Cash Accounting vs. Accrual Accounting, Accrual Basis Accounting

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Accrual Based Accounting

See Also:
Accrual Based Accounting GAAP Rules
Time Saving Tip for Filing Accounts Payable Invoices
Statement of Financial Accounting Standards – SFAS
Generally Accepted Accounting Principles (GAAP)
General Ledger Reconciliation and Analysis
Deferrals
Cash Basis vs Accrual Basis Accounting

Accrual Based Accounting Definition

The accrual based accounting definition, or accrual basis accounting, forms a method of recording financial transactions based on economic impact. In the accrual accounting method, record revenues when earned. Then, record costs when incurred, whether or not cash has actually been exchanged between the relevant parties. Contrast this method with cash basis accounting, which records transactions only when cash has been exchanged between the relevant parties. The accounting world uses the accruals concept well, in the accounting world it is far more common to use accrual accounting rather than cash accounting. The accrual definition may also vary based on industry and business model.


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Cash Basis Accounting Method

Cash basis accounting is a method of recording financial transactions which records transactions only when cash has been exchanged between parties. This contrasts with accrual basis accounting, which records transactions based on economic impact. When thinking about accrual vs cash accounting, remember that accrual keeps record of any sales where cash keeps record of income only. It is also possible to perform accrual to cash adjustments and conversions in accounting records.

Cash vs Accrual Basis

When a company sells its product to a customer, it must record the transaction. Using cash basis accounting, the company would not record the revenue from the sale until it received the cash from the customer. Using the accrual method of accounting, the company would record the revenue from the sale once the customer has received the product, whether or not the company has received the cash from the customer. The accrual method seeks to record the entire process of a transaction.

Accrual basis accounting gives a more accurate depiction of a company’s financial condition. However, implementing it is more complicated and more costly than cash basis accounting. Accrual accounting is often used in situations with complexities beyond that of the simple sole proprietorship.

All companies that report financial statements according to GAAP rules use accrual accounting. Only very small and unsophisticated businesses (a local coffee shop, an antique store with little inventory, etc.) would use cash basis accounting.

Accrual Principle

Derive accrual basis accounting on two fundamental accounting principles: the revenue recognition principle and the matching principle.

Accrual Basis Statements

According to GAAP, and in accordance with the revenue recognition principle and the matching principle, you must prepare all financial statements using accrual accounting.

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accrual based accounting

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