What is Accrual and Cash Basis Accounting and The Difference

Accounting is the process of tracking and recording financial transactions. There are two main methods of accounting: accrual basis and cash basis. Accrual basis accounting records revenue and expenses when they are incurred, regardless of when cash is received or paid. Cash basis accounting records revenue and expenses when cash is received or paid.

Accrual Basis and Cash Basis

Accrual Basis Accounting

Accrual basis accounting is the more accurate method of accounting, as it reflects the true financial performance of a business. This is because accrual basis accounting records revenue and expenses when they actually occur, rather than when cash is received or paid.

For example, let's say a business sells a product on credit. Under accrual basis accounting, the revenue from the sale would be recorded when the product is sold, even if the customer does not pay for it until later. This is because the business has earned the revenue even though it has not yet received the cash.

Similarly, let's say a business incurs an expense for rent. Under accrual basis accounting, the expense would be recorded when the rent is incurred, even if the business does not pay the rent until later. This is because the business has incurred the expense even though it has not yet paid for it.

Cash Basis Accounting

Cash basis accounting is a simpler method of accounting that is often used by small businesses. Under cash basis accounting, revenue is recorded when cash is received, and expenses are recorded when cash is paid.

For example, let's say a business sells a product on credit. Under cash basis accounting, the revenue from the sale would be recorded when the customer pays for the product, not when the product is sold. This is because the business has not yet received the cash from the sale.

Similarly, let's say a business incurs an expense for rent. Under cash basis accounting, the expense would be recorded when the business pays the rent, not when the rent is incurred. This is because the business has not yet paid for the expense.

Which Method is Right for You?

Which method of accounting is right for a business depends on the specific circumstances of the business. If a business needs to track its financial performance accurately, then accrual basis accounting is the better choice. However, if a business needs a simpler and easier-to-understand method of accounting, then cash basis accounting may be a better option.

Here are some factors to consider when deciding which method of accounting is right for your business:

• The size of your business: Cash basis accounting is generally simpler to use for small businesses. However, as a business grows, it may need the accuracy of accrual basis accounting.

• The nature of your business: Some businesses, such as businesses that sell products on credit, may need to use accrual basis accounting to track their receivables.

• Your tax situation: The method of accounting you use may affect your taxes. For example, if you use accrual basis accounting, you may be able to deduct expenses that you have incurred even if you have not yet paid for them.

Consulting an Accountant

If you are not sure which method of accounting is right for your business, you should consult with an accountant at Accounts Pro Outsourcing. Contact now for free consultancy service.

Conclusion

Accrual basis accounting and cash basis accounting are two different methods of accounting. Accrual basis accounting is more accurate, but it is also more complex. Cash basis accounting is simpler, but it is less accurate. The best method of accounting for a business depends on the specific circumstances of the business.

Additional Information

• Accrued Revenue: Accrued revenue is revenue that has been earned but not yet received. For example, a business may sell products on credit. The revenue from these sales would be recorded as accrued revenue when the products are sold, even though the business has not yet received the cash from the sales.

• Accrued Expenses: Accrued expenses are expenses that have been incurred but not yet paid. For example, a business may incur an expense for rent. The expense would be recorded as accrued expense when the rent is incurred, even though the business has not yet paid the rent.

• Deferred Revenue: Deferred revenue is revenue that has been received but not yet earned. For example, a business may receive a deposit from a customer for a product that has not yet been delivered. The deposit would be recorded as deferred revenue until the product is delivered.

• Deferred Expenses: Deferred expenses are expenses that have been paid but not yet incurred. For example, a business may purchase a prepaid insurance policy. The cost of the insurance policy would be recorded as deferred expense until the insurance coverage is used.