Accounting methods define consistent ways of recording transactions in your business accounting books and records. The point of this is to make the business data and information useful by allowing comparability with other businesses and for making decisions to really understand how profitable a business is. There are two methods of accounting, the first is cash accounting and the other is accrual accounting. In this blog, we will go through the complete difference between both cash accounting and accrual accounting. This article has the following main topics.
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Definition Of Cash Accounting
The Cash Basis Of Accounting is a method of recording financial transactions. Under this method, transactions are only recorded when cash changes hand. In simple words, on the cash basis of accounting, income is recorded when cash is actually received-meaning you have done the work, you have sold the products, and now you have actually received the cash payment.
The cash basis of accounting does not require high knowledge and study as a person having little knowledge of bookkeeping can maintain business records as per this system with this method. Like every accounting system, this method has also pros and cons.
Pros Of Cash Accounting
Some of the advantages of cash basis of accounting are as follows.
- The main benefit of using cash accounting practices is their simplicity. You don’t need advanced skills and knowledge to add and subtract income and payments.
- The cash basis of accounting lets you easily see how much cash you actually have on hand.
- Many countries accept this method of accounting for tax purposes so long as your earnings are below a certain threshold
Cons Of Cash Accounting
The cons of the cash accounting method are as follows.
- When you cash account, you don’t have an accurate way of recording your profits and so there can be huge fluctuations in your results. This is caused by recording income and expenses in separate accounting periods.
- A business cannot use cash basis accounting if it sells products on services, has gross receipts higher than the IRS requirements, and need inventory to account for income.
- The cash accounting method is good for reporting the financial health of the business at a given time, but it fails to provide a complete image.
Definition Of Accrual Accounting
In Accrual Accounting the income is reported when it’s completely earned by you regardless of when they pay you. In the accrual method, it does not matter when the customer pays you and when you pay the bills and expenses. Everything is based on when income is earned and when expenses are incurred.
This method is preferred and accepted by most of the businesses as this method not only provides present data of revenue and expenses, but also predicts the cash receipts and expenditures expected to arise in the future. The pros and cons of this system are included as well and they are as follows.
Pros Of Accrual Accounting
Three of the advantages of accrual accounting are as follows.
- The matching and expenses using this method grant you more useful business analysis.
- This method conforms to GAAP(Generally Accepted Accounting Principles) and is required by almost all firms.
- Accrual accounting reflects certain future cash flow activities, and so it enables much better strategic planning.
Cons Of Accrual Accounting
- If you are already working with another method of accounting, it can be difficult to switch to an accrual basis.
- Any incorrect calculation in this method could lead to inexact revenue and expense numbers leading to overspending and losing profit.
- The accrual method can be challenging to manage without knowledge and available resources.
Cash Accounting Vs Accrual Accounting(Comparison Table)
|Basis For Comparison||Cash Accounting||Accrual Accounting|
|Definition||Cash accounting refers to the basis of accounting where income or expenses are recognized only when there is an inflow and outflow of cash.||It refers to the basis of accounting where income or expenses are recognized when it is earned.|
|Nature||Cash accounting is simple in nature.||Accrual accounting is complex in nature.|
|Accuracy||It has low accuracy||It has comparatively high accuracy.|
|Income Statements||Income statements will show lower income.||Income statements show a comparatively higher income|
|Accounting System||It follows the single entry system that records either inflow or outflow of cash.||It follows a double-entry system of accounting.|
|Suitability||It is suitable for small businesses||It is suitable for large companies.|
Key Differences Between Cash Accounting And Accrual Accounting
Since we are comparing cash accounting vs accrual accounting, let’s have a look at some of the key differences between them.
- The Cash Basis Of Accounting is a method of recording financial transactions. Under this method, transactions are only recorded when cash changes hand. On the other hand, in Accrual Accounting the income is reported when it’s completely earned by you regardless of when they pay you.
- Cash Accounting is simple and can be easily managed. On the other hand, Accrual Accounting is comparatively complex in nature.
- Cash accounting recognizes revenue when the cash amount for the sold products and services is received while accrual accounting does not wait for receiving the cash.
- The degree of accuracy in cash accounting is less. On the other hand, the degree of accuracy in accrual accounting is comparatively higher.
- The accrual basis of accounting is a recognized method while the cash basis of accounting is not a recognized method as per companies.
- The cash accounting method is mostly used by small businesses or sole proprietors who have no inventory to maintain. On the other hand, large companies or enterprises prefer accrual accounting.
With the above explanations, we can simply conclude that large companies or businesses should prefer an accrual basis of accounting while small enterprises should focus on the cash basis of accounting. The Cash Basis Of Accounting is a method of recording financial transactions. Under this method, transactions are only recorded when cash changes hands. On the other hand, in Accrual Accounting the income is reported when it’s completely earned by you regardless of when they pay you.