Cash Based Accounting Vs Accrual Accounting: The Key Difference

Cash Based Accounting Vs Accrual Accounting: The Key Difference

CASH BASED ACCOUNTING

The cash-based accounting identifies and accepts revenues only when the cash is received, and paid expenses. Accounts Receivable and Accounts Payable is not recognized in this factor of accounting.

Considering its Simplicity and accountability, many small businesses consider opting for cash-based accounting. It's very easy to track the financial transactions if any and hence there is no necessity for Accounts receivable and accounts payable to come into picture.

The cash method actually benefits you in tracking how much your business withdraws cash at any given time. And, since there will be no record of transactions until the cash payment or delivery, You will not be able to tax your business profit and income.

ACCRUAL BASED ACCOUNTING

Accrual accounting records the revenues and expenses when they are earned, nevertheless of when the money is actually received or paid. Say, for example, only when a project is complete, you go to record the revenue comparatively when you get paid. Hence, this accrual method is more widely used than the cash method.

A positive aspect of the accrual basis is that it gives a more practical idea of income and expenses during the accounting period, and it consequently provides a long-term ideology of the business that cash accounting never provides.

The limitation of accrual accounting is that it doesn’t provide any acknowledgment about cash flow. A mirage can appear straight in front of you. As you find your business running much successful but in reality, it has bare bank accounts. Caution must be kept near you while working in Accrual accounting. If there is negligence in careful monitoring of cash flow then it can lead to severe ravaging results.

CASH AND ACCRUAL BASED ACCOUNTING EXAMPLES:

A real-life example is quoted below for revenue and expense recognition:

  • Revenue recognition: An organization is selling $900 of garden equipment to their customer in November month, which will pay the invoice in December. From the perspective of the cash end, the seller recognizes the sale in December, when the actual cash is received. From the accrual perspective, the seller identifies the sale in November itself, when it distributes the invoice.

  • Expense recognition: A company buys $1300 of office furniture in February, which it will pay for in March. From the cash perspective, the customer identifies the purchase in March, when it actually pays for the invoice. From the accrual perspective, the customer recognizes the purchase in February, when it receives the provider's invoice.

LITERAL DIFFERENCES BETWEEN CASH AND ACCRUALS

The below comparison chart shows the differences between cash basis and accrual basis clearly,

 

CASH BASED ACCOUNTING

ACCRUAL BASED ACCOUNTING

Revenue is identified when as soon cash is received

Accrual accounting recognizing revenue only during the accounting period completion.

Cost price(Expenses) are recognized when actual money in hand is spent

Expenses are recognized when an invoice is received

Need not pay tax for the money that has not reached your hands.

The Tax must be paid for the debt that you're liable to.

Usually, it is owned by small businesses.

Accrual accounting is used by large ventures who own turnover in millions.

 

Any type of accounting(including cash basis and accrual basis) uses the below 3 financial statements as records. So there is nothing wrong to get familiarized with these statements. These statements primarily concentrate on financial transactions and track revenue.

 

  • Balance sheets: This sheet shows if your assets(properties) equals your debts.

  • Income statements: To calculate your net income, Income statements normally list your profits and losses.

  • Cash flow statements: This clearly records how much cash is flowing in and out of your business. It also records the profit and loss of the business. 

IRS STATEMENTS 

Internal Revenue Service(A Federal Agency) claims that Cash-based Accounting is the easiest accounting method for recording and tracking any financial transactions because there is no need for any intrusion of complex accounting transactions namely accrual and deferrals.

IRS also suggests that the Cash-based method is the only practical method available if a company settles within $5 million in sales per year. 

IRS is the one who brought light to the accounting world that Cash-based accounting methods should be used by small businesses because of their flexibility.

Let us see further what the IRS suggests about Accrual Accounting.

IRS recommends Accrual accounting to come into practice only if the company's sales exceed over $5 million. And truly, larger companies are flexible to use the accrual basis method to record their financial transactions.

Magically, Through accrual accounting, the business financial results have a higher probability to match revenues and expenses in the same accounting period, which makes it easier to calculate the exact profitability of the business.

The IRS standard statements of cash basis and accrual basis of accounting have led to an easier understanding of concepts and the practical way to use them among financial accountants.

Their statements are widely accepted by many economists too.

MERITS OF CASH BASED ACCOUNTING OVER ACCRUAL BASED ACCOUNTING

One advantage of the Cash basis method is it is more immediate(faster) in recognizing revenue and expenses, where the accrual-based method of accounting concentrates on the predicted and foreseen revenue and expenses.

Cash-based accounting is primarily used to track the cash flow through the company. Accrual based accounting always includes accounts receivables and payables for the long-term profitability of a company. 

WINDING UP HERE: 

Hope Calman Analytics has covered the concepts of Cash and Accrual Accounting clearly. Again, bringing the important idea in both one more time. The difference between the cash basis and accrual basis of accounting is the recorded timing of the revenue and expenses. Since Calman Analytics always focuses on helping Business professionals with accounting exercises, we hope the difference between cash and accrual accounting is clearly explained in each paragraph in this blog. Reach us for more accounting queries and our technical team is always ready to assist you regarding business clarifications.

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