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What Is the Difference Between Cash and Accrual Accounting?

 

Accrual basis and cash basis are two methods of accounting used to record transactions.

The key difference between the two methods is the timing in which the transaction is recorded. Over time, the results of the two methods are approximately the same.

Here is a brief overview of both methods:

Accrual Basis: The transaction and revenue are recorded when earned and expenses are recorded when consumed.

Cash Basis: The transaction and revenue are recorded when cash is received from customers. Expenses are recorded when cash is paid to suppliers and employees.

As per the IRS regulations, the cash basis method is only available if a company has no more than $5 million in sales per year. Cash basis is the easiest accounting method for recording transactions because no complex accounting transaction such as accrual and deferrals are needed. This method is widely used in small businesses because it is so easy to use. However, the random timing of cash receipts and expenditures means that results reported can vary between unusually high and low profits

Although the IRS requires (and can only audit) all companies with sales exceeding over $5 million dollars, there are other reasons larger companies use the accrual basis method to record their transactions. Under accrual accounting, financial results of a business are more likely to match revenues and expenses in the same reporting period, so that the true profitability of a business can be recognized. Unless a statement of cash flow is included in the company’s financial statements, this approach does not reveal the company’s ability to generate cash.

This article will also include information on:

What Is the Main Difference Between Cash and Accrual Accounting?

What Is Better Cash or Accrual Accounting?

What Is the Main Difference Between Cash and Accrual Accounting?

The main difference between accrual and cash basis accounting is the timing of when revenue and expenses are recorded and recognized. Cash basis method is more immediate in recognizing revenue and expenses, while the accrual basis method of accounting focuses on anticipated revenue and expenses.

Here are some examples that apply these concepts:

Revenue Recognition

A company sells $20,000 of product to a customer in August. The customer pays that invoice in September. With the cash basis method, the company recognizes the sale in September, when cash is received. Whereas with the accrual basis accounting, the company recognizes the sale in August, when it is issued the invoice.

Expense Recognition

A company buys $700 of office supplies in March, which it pays for in April. With the cash basis method, the company recognizes the purchase in April, when it pays the bill. Whereas with the accrual basis accounting, the company recognizes the purchase in March, when it received the supplier invoice.

What Is Better Cash or Accrual Accounting?

Both accrual and cash basis accounting methods have their advantages and disadvantages but neither shows the full picture about a company’s financial health. Although, accrual method is the most commonly used by companies, especially publicly traded companies. A reason for the accrual basis method of accounting popularity is that it levels out earnings overtime since it records all revenue and expenses as they’re generated instead of being recorded sporadically like they are under the cash basis method.

Here are the advantages and disadvantages of both accounting methods.

Cash Basis Accounting Method

Advantages

Disadvantages

It is simple to use, since it only accounts for cash paid or received.

It is easier to track the cash flow of a company.

Might overstate the health of a company that is cash-rich but has large sums of accounts payables that far exceed the cash on the books and the company’s current revenue stream.

Investors might conclude the company is making profit when in reality it is losing money.

 

Accrual Basis Accounting Method

Advantages

Disadvantages

Including accounts receivables and payables allows for a more accurate picture of the long-term profitability of a company.

Doesn’t track cash flow and as a result, might not account for a company with a major cash shortage in the short term, despite looking profitable in the long term.

Can be more complicated to implement since it’s necessary to account for items like unearned revenue and prepaid expenses.

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