Accrual Accounting vs. Cash Basis Accounting: What's the Difference? (2024)

Accrual Accounting vs. Cash Basis Accounting: An Overview

The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method providesan immediate recognition of revenue and expenses, while the accrual method focuses on anticipatedrevenue and expenses.

Key Takeaways

  • Accrual accounting records revenue and expenses when transactions occur but before money is received or dispensed.
  • Cash basis accounting records revenue and expenses when cash related to those transactions actually is received or dispensed.
  • Accrual accounting provides a more accurate view of a company's health by including accounts payable and accounts receivable.
  • The accrual methodis the more commonly used method by large companies, especially by publicly-traded companies, as it smooths out earnings over time.
  • The cash basis method typically is used by sole proprietors and smaller businesses.

Accrual Accounting

Under this method, revenue is accounted forwhen it is earned. Unlike the cash method, the accrual method records revenue when a product or service is delivered to a customer with the expectation that money will be paid in the future.In other words, money is accounted for before it's received. Likewise, expenses for goods and services are recordedbefore any cash is paid out for them.

Cash Basis Accounting

Under this method, revenue is reported on the income statementonly when cashis received. Expensesare recorded only when cashis paid out. The cash method is typically used by small businesses and for personal finances.

Key Differences

Accrual Method

The accrual methodrecordsaccounts receivables and payables and, as a result, can provide a more accurate pictureof the profitability of a company,particularly in the long term.

For example, a company might havesales in the current quarter that wouldn't be recorded under the cash method. The related revenue is expected in the following quarter. An investor might think the companyis unprofitable when, in reality, the company is doing well.

The accrual method doesn't track cash flow. A company might lookprofitable in thelong term but actually have achallenging, major cashshortagein the short term.

Another disadvantage of theaccrual method is that it can be more complicated to use since it'snecessary toaccount for items like unearned revenueand prepaid expenses.It also may require added staff.

The accrual method typically is required for companies that file audited financial statements and is required under the generally accepted accounting principles (GAAP) issued by the Financial Accounting Standards Boards (FASB).

Cash Basis Method

The key advantage of the cash method is its simplicity—it only accounts for cash paid or received. Tracking the cash flow of a company is also easier.

It's beneficial to sole proprietorships and small businesses because, most likely, it won't require added staff (and related expenses) to use.

However, the cash basis method might overstate the health of a companythat iscash-rich. That's because it doesn't record accountspayablesthat might exceedthe cash on the booksand the company'scurrent revenue stream.

As a result, an investor might conclude the companyis making a profit when, in reality, the company might be facing financial difficulties.

The cash basis method is not acceptable under GAAP.

Tax Law Change

The Tax Cuts and Jobs Act increased the number of small business taxpayers who were entitled to use the cash basis accounting method. As of January 2018, small business taxpayers with average annual gross receipts of $25 million or less in the prior three-year period could use it.

Special Considerations

The accrual methodis the more commonly used method, particularly by publicly-traded companies. One reason forthe accrual method's popularityis thatit smooths out earnings over time since it accounts for all revenues and expensesasthey'regenerated. The cash basis method records these only when cash changes hands and can present more frequently changing views of profitability.

For example, under the cash basis method,retailers would look extremely profitable in Q4 asconsumers buy for the holiday season.However, they'd look unprofitablein the next year's Q1 asconsumer spending declinesfollowing the holidayrush.

Both methods have their advantages and disadvantages. Each provides different views of the financial health of a company. For investors, it's important to understand the impact of both methods when making investment decisions.The vasty majority of companies that people would potentially invest in, will be using accrual-based accounting. However, should you come across a small company using cash-based accounting, it's definitely something to watch out for.

Accrual Accounting vs. Cash Basis Accounting Example

Let's say you own a business that sells machinery. If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check.

Under the accrual method, the $5,000 is recorded as revenue as of the day the sale was made, though you may receive the money a few days, weeks, or even months later.

The same principle appliestoexpenses. If the company receivesan electric bill for $1,700, under the cash method, the amount is not recorded until the companyactually pays the bill. However, under the accrual method, the $1,700 is recorded as an expense the day the company receives the bill.

What Is Accrual Accounting?

Accrual accounting is an accounting method that records revenues and expenses before payments are received or issued. In other words, it records revenue when a sales transaction occurs. It records expenses when a transaction for the purchase of goods or services occurs.

What Is the Difference Between Cash and Accrual Accounting?

Cash basis accounting records revenue and expenses when actual payments are received or disbursed. It doesn't account for either when the transactions that create them occur. On the other hand, accrual accounting records revenue and expenses when those transactions occur and before any money is received or paid out. Companies might also use modified accrual accounting and modified cash basis accounting.

When Does a Company Account for Revenue If It Uses Cash Basis Accounting?

Under the cash basis accounting method, a company accounts for revenue only when it receives payment for the products or service it provided a customer.

Accrual Accounting vs. Cash Basis Accounting: What's the Difference? (2024)

FAQs

Accrual Accounting vs. Cash Basis Accounting: What's the Difference? ›

The difference between cash and accrual accounting lies in the timing of when sales and purchases are recorded in your accounts. Cash accounting recognizes revenue and expenses only when money changes hands, but accrual accounting recognizes revenue when it's earned, and expenses when they're billed (but not paid).

What are the differences between cash and accrual basis accounting? ›

Cash basis accounting records revenue and expenses when actual payments are received or disbursed. It doesn't account for either when the transactions that create them occur. On the other hand, accrual accounting records revenue and expenses when those transactions occur and before any money is received or paid out.

What is the benefit of accrual accounting compared to cash accounting? ›

The upside of accrual accounting is that it gives you a more realistic picture of the financial health of your business because it tracks all income and expenses. This offers long-term insight into your business operations. The downside is that it doesn't reflect the actual cash flow of the business.

Does accrual accounting produce better information than cash basis accounting? ›

Accrual accounting uses double-entry accounting, where there are generally two accounts used when entering a transaction. This method is more accurate than cash basis accounting because it tracks the movement of capital through a company and helps it prepare its financial statements.

What is the difference between cash basis accounting and accrual basis accounting quizlet? ›

The main difference between accrual and cash basis accounting is the timing of when revenue and expenses are recognized.

How do you explain accrual accounting? ›

Accrual basis accounting recognizes business revenue and matching expenses when they are generated—not when money actually changes hands. This means companies record revenue when it is earned, not when the company collects the money.

What is an example of an accrual in accounting? ›

For example, if the company has provided a service to a customer but has not yet received payment, it would make a journal entry to record the revenue from that service as an accrual. This would involve debiting the "accounts receivable" account and crediting the "revenue" account on the income statement.

What are the pros and cons of cash basis versus accrual? ›

The cash-basis approach is easy to use, but it often fails to provide a complete picture of a business's finances. Meanwhile, the accrual method requires a more thorough approach that makes it easy to form a complete financial picture of your company and its current health.

Who cannot use the cash method of accounting? ›

In general, the cash method of accounting cannot be used by: C corporations; partnerships that have one or more C corporations as a partner or partners; and. tax shelters.

What are the disadvantages of cash basis of accounting? ›

Disadvantages of Cash Basis of Accounting

1. It provides a less accurate picture of the financial position of the business as compared to the accrual basis of accounting. 2. Business data can be manipulated by deferring payments or late deposit of cheques.

Why do banks prefer accrual basis accounting? ›

GAAP prefers the accrual accounting method because it records sales at the time they occur, which provides a clearer insight into a company's performance and actual sales trends as opposed to just when payment is received.

What are the disadvantages of accrual accounting? ›

The Disadvantages of Accrual Accounting

There are several rules that need to be followed and a consistent process must be established for defining when and how to record certain types of expenses and income. Additionally, tax forms can be slightly more complicated to complete when using the accrual accounting method.

Why do businesses prefer accrual accounting? ›

Accrual accounting gives a more accurate, real-time view of a company's finances. Many financial transactions are completed through credit or invoicing at a later date. With accrual accounting, these future payments (made or received) are recorded when the service happens or the good is delivered.

Why accrual basis is better than cash basis? ›

Accrual basis accounting is typically best because it offers the most accurate information about your business's performance. But its complexity may outweigh its benefits for simple, very small businesses.

What is the difference between accrual and cash basis in Quickbooks? ›

Expenses on the accrual basis include everything you owe, regardless of whether or not you have sent a payment. Expenses on the cash basis include only the expenses that you have already paid. As a business owner, it is important to track your income and expenses in order to break even.

What are the pros and cons of cash vs accrual accounting? ›

The cash-basis approach is easy to use, but it often fails to provide a complete picture of a business's finances. Meanwhile, the accrual method requires a more thorough approach that makes it easy to form a complete financial picture of your company and its current health.

What is the difference between the cash basis and the accrual basis of accounting quizlet Chapter 45? ›

What is the difference between the cash basis and the accrual basis of accounting? In the cash basis of accounting, income is recorded when it is received. In the accrual basis of accounting, income is recorded when goods are shipped (or services provided).

Is cash or accrual better for taxes? ›

For some businesses, however, the accrual method may be preferable. For instance, if a company's accrued income tends to be lower than its accrued expenses, the accrual method may result in lower tax liability than the cash method.

References

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