Cash vs Accrual accounting – Both these accounting systems are common among businesses to keep track of their revenues and expenses. However, which one to use depends on the business model, as well as the earnings of the business. You will have to ensure that you have the best bookkeeping methods in place. This will allow you to ensure that your business model meets the requirements of the government.
In this article, you will learn about the cash basis accounting system, as well as accrual accounting. Apart from that, we will share with you the difference between these two most common systems of accounting that businesses resort to. Apart from that, you will also get to learn the major pros and cons of both these accounting systems. Hence, to learn more, read on through to the end of the article.
What Is Cash Accounting?
Here, the company records transactions only when the cash physically moves in or out of the business. It recognizes the revenue and expenses when it fully receives the money or spends the money in respective cases.
According to Nerdwallet.com,
“Cash basis accounting is easy to implement, maintain and understand. And if you maintain your books on a cash basis, there will be little difference between your financial statements and your tax returns. This means your cash basis income statement can come pretty close to accurately mirroring your business’s cash flow statement.”
This helps the owners of the business who want to get a quick idea of the cash flow of the business from one financial statement.
What Is Accrual Accounting?
According to Investopedia,
“Accrual accounting is a financial accounting method that allows a company to record revenue before receiving payment for goods or services sold and record expenses as they are incurred.In other words, the revenue earned and expenses incurred are entered into the company’s journal regardless of when money exchanges hands.”
Certain businesses cannot use the cash-basis accounting method, as per the provisions of the Tax Reform Act of 1986.
One of the best things about accrual accounting is that it gives the company an accurate picture of the financial health of the business. This is because it takes into account the unpaid expenses or the unreceived revenues.
Cash Vs Accrual Accounting: What Is The Difference?
The following are the major points of differences between cash basis accounting and accrual accounting:
|Cash Basis Accounting||Accrual Accounting|
|The business records transactions when the business receives the cash or spends the money.||The business records transactions when a sale has occurred, or an expense is made, even if money is not received/ spent.|
|The tax liability is incurred only when the business receives the income.||The tax liability is incurred after the income is recorded, even when the business does not receive the income.|
|This is a simple system and easy to record.||This is a complicated system and consists of many extensive rules and regulations.|
|A useful option for small businesses.||It makes things easier for large businesses.|
Pros And Cons Of Cash Basis Accounting
The following are the major pros and cons of cash basis accounting:
Pros Of Cash Basis Accounting
Here are some pros of cash basis accounting from which you shall benefit a lot:
- It lets you ensure that the business already receives the cash.
- There is more control over the transactions, resulting in reliable cash management. This also ensures tax advantages.
- Tracking income and expenses is easier.
- Until you receive the money in your account or until the transaction happens, there is no taxation on the income.
Cons Of Cash Basis Accounting
Here are a few cons of cash basis accounting which you must be aware of:
- It does not show the liabilities of the business since it does not reflect the future payables of the business.
- It is not a great option for large companies, as it complicates things.
- Transitioning to accrual accounting is difficult and can lead to mismanagement of the finances of the company.
Pros And Cons Of Accrual Accounting
According to Business News Daily,
“Under the accrual basis accounting method, income and expenses are recorded when they are accrued, not when the money actually comes in or goes out. Accrual basis is the more common method of accounting, and it’s mandatory for corporations that have gross receipts of $26 million or more in any of the past three years.”
The following are the major pros and cons of accrual accounting:
Pros Of Accrual Accounting
Here are some pros of accrual accounting from which you shall benefit a lot:
- You will be able to check future revenues and expenses in a better manner. Here, you will get to see a full picture of the finances of the business.
- You can get to see a more accurate picture than cash basis accounting.
- You will be able to do tax savings on depreciation. This will help you to save money on taxes in the long run.
Cons Of Accrual Accounting
Here are a few cons of accrual accounting that you must be aware of:
- There are extensive rules and regulations that make things complicated.
- More work is required than cash accounting. There is always a need for a specialist.
- The account does not always reflect the money that is always available.
- You will have to pay taxes on income that you have not yet received.
Cash vs accrual accounting – Hope this article was helpful for you in getting a better idea of both these accounting systems and when do businesses use one of these systems. The accrual accounting system records revenue and expenses during transactions and before receiving money. On the other hand, cash accounting records after the cash is received or dispensed.
In most large companies, the accrual method of accounting is commonly used, especially the ones that are publicly traded companies. It helps in getting a better idea of the finances. Do you have any more differences to add regarding these two systems? Share your ideas with us in the comments section below.