Differences Between Cash Accounting and Accrual Accounting

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Yarab A | Jul-06-2020

To account your business books, you need to follow the principle as defined by the accounting methods. There are two primary accounting methods – Cash accounting and Accrual accounting that a business a choose and apply. Each method has its own way of accounting and impacts differently on how the business financials are measured.

A method that is right for one type of business, may not be accurate for others. It is important for businesses to know the difference between cash basis accounting and accrual basis of accounting, understand the impact and choose the one that suits your business.

Before we get into the key factors that differentiates cash accounting and accrual accounting, let us understand the fundamentals with examples.

Under the cash accounting method, transactions are recorded only when money changes hands. For example, On 1st June,2020, Max fashions sold garments worth Rs. 1,00,000/-. 40% on cash and remaining on a credit basis. Max fashions maintain accounts using the cash method.

On following the cash-based accounting method, Max fashions would recognize revenue to the extent of Rs. 40,000/- (i.e., 1,00,000*40%) on 1st June. Remaining would be recognised as an when it is received.

Under the accrual-based method of accounting, gross income/expenses are reported when it is earned/occurred, regardless of when the income/expenses are collected/paid.

If the above example is maintained in the accrual accounting method, 1,00,000 will be recognized as revenue on the date of sale. The credit sale of 60,000 will be recognized as accounts receivables and 40,000 as cash.

With this understanding let us discuss the difference between cash and accrual basis accounting.

Difference between cash accounting and accrual accounting

We have listed the key differences of cash accounting and accrual accounting that will help you decide on the accounting method.

Cash Accounting Vs Accrual Accounting

Key factors

Cash accounting

Accrual accounting

Time of recognising revenue and expenses

Revenues are recognized when they are received, while expenses are recognized when paid for

The revenue/expenses will be accounted for when it is earned/occurred, regardless of when the income/expense is collected/paid

Usage of the accounting system

Cash accounting method applies the single-entry accounting system to manage the books. In which, the one aspect of cash, either going out or coming in is recorded

Double entry accounting system is followed by business who chose the accrual basis of accounting. Here, two aspects for every transaction is recorded in the books i.e. a receiving aspect and giving aspect in the form Dr and Cr

Impact on tax accounting and reporting

Cash basis accounting method is not suitable for managing and reporting the tax, especially the indirect tax. Because you will account the tax only when the invoice is paid instead of the date on which sale is made. Usually, the tax liability needs to be accounted on sales date

The most suitable method for accounting tax is the accrual method. Since all the transactions are accounted on the date they are made, the tax aspect too will be accounted, irrespective of whether the invoice is paid or not. Thus, the tax liability will be recorded and reported accurately

Impact on accounts receivable and payables

A big no to cash accounting method If you are a business who sells most on credit. Fundamentally, it records only when cash is exchanged, details of receivables and payables will not be recorded

Since the accrual basis of accounting follows the double-entry system, the suppliers account for payables and customers account for receivables are accounted when transactions are made on credit. Thus, clear and accurate details of accounts receivables and payables are managed

Business suitability

This is suitable for a micro-sized business who deal mostly on a cash basis with less or no credit transactions

For small to large businesses, it is wise to opt for the accrual method of accounting as it provides accurate details including the accounts receivables and payables

Ease of accounting

Cash accounting is a simpler method that records only one aspect i.e. payments or receipts

The accrual method is little is complex as it involves recording all aspects of every transaction done in the business

Holistic view of business

Cash accounting does not take every transaction into accounting. As a result, the financials reports cannot be complete

By recording all the transaction into the accounting reports, the financial reports prepared using the accrual method are accurate and complete

Usefulness

Business can quickly know the liquidity and how much cash the business has generated

The accrual method of accounting is holistic, and one can get to know the details of P&L and true financial position of the business

There is no right or wrong in choosing a cash or accrual method. Each method works differently and has its own advantages or disadvantages. Businesses need to consider their transactions, operations and choose the one that fits the best.

If you are a micro-business doing most of the transactions on cash with less or no credit, the cash accounting will be easy and simpler one to follow. On the other side, if you have a good number of transactions on credit, both buying and selling, the accrual method will be beneficial.

Once you understand the fundamental difference between cash accounting and accrual accounts, it becomes a lot easier to make the right choice.  Another important factor to consider here is the flexibility of accounting software. No matter which accounting method you choose, the accounting software that you use should be flexible enough to support the method you have opted.

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