Accrual Accounting vs. Cash Basis Accounting: What's the Difference? (2024)

Accrual Accounting vs. Cash Basis Accounting: An Overview

The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method providesan immediate recognition of revenue and expenses, while the accrual method focuses on anticipatedrevenue and expenses.

Key Takeaways

Accrual accounting records revenue and expenses when transactions occur but before money is received or dispensed.
Cash basis accounting records revenue and expenses when cash related to those transactions actually is received or dispensed.
Accrual accounting provides a more accurate view of a company's health by including accounts payable and accounts receivable.
The accrual methodis the more commonly used method by large companies, especially by publicly-traded companies, as it smooths out earnings over time.
The cash basis method typically is used by sole proprietors and smaller businesses.

Accrual Accounting

Under this method, revenue is accounted forwhen it is earned. Unlike the cash method, the accrual method records revenue when a product or service is delivered to a customer with the expectation that money will be paid in the future.In other words, money is accounted for before it's received. Likewise, expenses for goods and services are recordedbefore any cash is paid out for them.

Cash Basis Accounting

Under this method, revenue is reported on the income statementonly when cashis received. Expensesare recorded only when cashis paid out. The cash method is typically used by small businesses and for personal finances.

Key Differences

Accrual Method

The accrual methodrecordsaccounts receivables and payables and, as a result, can provide a more accurate pictureof the profitability of a company,particularly in the long term.

For example, a company might havesales in the current quarter that wouldn't be recorded under the cash method. The related revenue is expected in the following quarter. An investor might think the companyis unprofitable when, in reality, the company is doing well.

The accrual method doesn't track cash flow. A company might lookprofitable in thelong term but actually have achallenging, major cashshortagein the short term.

Another disadvantage of theaccrual method is that it can be more complicated to use since it'snecessary toaccount for items like unearned revenueand prepaid expenses.It also may require added staff.

Cash Basis Method

The key advantage of the cash method is its simplicity—it only accounts for cash paid or received. Tracking the cash flow of a company is also easier.

It's beneficial to sole proprietorships and small businesses because, most likely, it won't require added staff (and related expenses) to use.

However, the cash basis method might overstate the health of a companythat iscash-rich. That's because it doesn't record accountspayablesthat might exceedthe cash on the booksand the company'scurrent revenue stream.

As a result, an investor might conclude the companyis making a profit when, in reality, the company might be facing financial difficulties.

The cash basis method is not acceptable under GAAP.

Tax Law Change

The Tax Cuts and Jobs Act increased the number of small business taxpayers who were entitled to use the cash basis accounting method. As of January 2018, small business taxpayers with average annual gross receipts of $25 million or less in the prior three-year period could use it.

Special Considerations

The accrual methodis the more commonly used method, particularly by publicly-traded companies. One reason forthe accrual method's popularityis thatit smooths out earnings over time since it accounts for all revenues and expensesasthey'regenerated. The cash basis method records these only when cash changes hands and can present more frequently changing views of profitability.

Accrual Accounting vs. Cash Basis Accounting Example

Let's say you own a business that sells machinery. If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check.

Under the accrual method, the $5,000 is recorded as revenue as of the day the sale was made, though you may receive the money a few days, weeks, or even months later.

The same principle appliestoexpenses. If the company receivesan electric bill for $1,700, under the cash method, the amount is not recorded until the companyactually pays the bill. However, under the accrual method, the $1,700 is recorded as an expense the day the company receives the bill.

What Is Accrual Accounting?

Accrual accounting is an accounting method that records revenues and expenses before payments are received or issued. In other words, it records revenue when a sales transaction occurs. It records expenses when a transaction for the purchase of goods or services occurs.

What Is the Difference Between Cash and Accrual Accounting?

Cash basis accounting records revenue and expenses when actual payments are received or disbursed. It doesn't account for either when the transactions that create them occur. On the other hand, accrual accounting records revenue and expenses when those transactions occur and before any money is received or paid out. Companies might also use modified accrual accounting and modified cash basis accounting.

When Does a Company Account for Revenue If It Uses Cash Basis Accounting?

Under the cash basis accounting method, a company accounts for revenue only when it receives payment for the products or service it provided a customer.

As a seasoned expert in accounting and financial management, I bring a wealth of knowledge and hands-on experience to shed light on the critical topic of accrual accounting versus cash basis accounting. My extensive background includes in-depth familiarity with financial principles, accounting methods, and their practical applications in various business scenarios.

Now, delving into the concepts covered in the article, "Accrual Accounting vs. Cash Basis Accounting: An Overview," let's break down the key points:

Timing of Revenue and Expenses:
- Accrual Method: Recognizes revenue and expenses when transactions occur, irrespective of the cash flow. This method provides a forward-looking perspective, accounting for anticipated revenue and expenses.
- Cash Basis Method: Recognizes revenue and expenses only when cash is received or paid out, focusing solely on the actual cash transactions.
Accuracy and Company Health:
- Accrual Method: Records accounts receivables and payables, offering a more accurate view of a company's profitability, especially in the long term. It doesn't track cash flow directly, potentially leading to differences between profitability and short-term cash availability.
- Cash Basis Method: Provides simplicity and ease of tracking cash flow but may overstate the financial health of a company that is cash-rich and may not reflect outstanding payables.
Applicability and Usage:
- Accrual Method: Primarily used by large companies, especially publicly-traded ones, as it aligns with Generally Accepted Accounting Principles (GAAP) and provides a comprehensive financial picture. It is required for companies filing audited financial statements.
- Cash Basis Method: Typically used by sole proprietors and smaller businesses due to its simplicity. However, it is not acceptable under GAAP.
Tax Law Impact:
- The Tax Cuts and Jobs Act increased the number of small business taxpayers eligible to use the cash basis accounting method, particularly those with average annual gross receipts of $25 million or less.
Special Considerations:
- The accrual method's popularity lies in its ability to smooth out earnings over time, presenting a more consistent view of a company's financial performance.
- Both methods have advantages and disadvantages, providing different perspectives on a company's financial health.
Example:
- Illustrates the difference between the two methods using a scenario where a machinery business sells products, showcasing how revenue and expenses are recorded under both accrual and cash basis accounting.
Definitions:
- Defines accrual accounting as a method recording revenues and expenses before payments are received or issued, capturing transactions when they occur.
- Highlights the difference between cash basis accounting (recording transactions when cash is received or disbursed) and accrual accounting.

This comprehensive overview equips readers with a solid understanding of the nuances between accrual and cash basis accounting, empowering them to make informed decisions, especially in the realm of financial investments.