Cash Basis Accounting Vs Accrual Basis Accounting
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Cash-basis accounting is one of the most basic types of accounting. With this approach, you record revenue as soon as you receive it and costs as soon as you pay them. Accounts payable, accounts receivable, and any long-term obligation accounts are not kept in a firm since it solely employs cash accounts. You record these transactions using single-entry accounting. Cash basis helps to understand the businesses record income and expenses when actually received and paid by the company.
Accrual basis is the combination of the matching principle and the revenue recognition principle. As per the cash basis accounting, it is easier to recognize and could be understood easily. In the case of accrual basis, it is the basis that is generally accepted accounting principle.
CASH BASIS ACCOUNTING
Revenue: Revenue will be reported on the accounting statement only when cash is received simultaneously, expenses will be recorded only when money is paid out. Irrespective of any credit sales or purchases.
Cash Payments and Cash Invoices: However, in cash accounting, it does not show the incoming payments, it provides an incomplete picture of the company's financial structure. It does not show any related recording of the lease payments or the revenue to be received that are booked but not shipped. It leads or misguides an unsound financial statement.
Uses of Cash Basis Accounting
As it includes a single entry, it is easily understood with no deep knowledge. No procedures for complex software. It can be handled with a single entry or spreadsheet. As it records all the cash inflows and cash outflows, it identifies the actual cash for a given period. Can accelerate payments to reduce taxable profits, thereby reducing tax liability.
Advantages of Cash Basis Method
- Easy of Use: Much easier for the business owners to implement and would be more cost effective.
- Tax Advantage: Some businesses may benefit from using cash accounting when it comes to taxes. The timing of Transactions can be controlled by the recording of income and expenses.
Disadvantages of Cash Basis Accounting
- Doesn’t know the accurate picture: It does not show the liabilities of the business. As it does not clearly specify the long-term debts and long-term finances.
- Restricted Use: As it may not be processed if you are dealing with products or services on credit. Having gross receipts higher than the IRS requirements. Need inventory to account for income.
- Difficult to change accounting methods: As your business grows, various accounting methods needed to be decided upon To change from cash to accrual, you need to make some adjustments.
ACCRUAL-BASIS ACCOUNTING
As it is the concept differs from cash basis accounting, it will record an expense and income as it is incurred. It records a company's record revenue and expenses in the balance sheet as accounts receivables, accounts payable, prepaid assets, and accrued expenses.
Advantages of accrual accounting
- It provides an accurate picture of overall cash flow for the business. Many of the business transactions occur after a period of several months and therefore many accounting periods. The income and expenses related to the accrual accounting would be reflected in the month or carried to the next month or takes an even longer period.
- Investors prefer accrual accounting. As in the case of accrual accounting, are more often permanent and established than the business functioning with cash basis of accounting.
- It's the preferred method for GAAP. The financial statements of a business using accrual basis of accounting is often looked accurate as it is set by Generally Accepted Principles set forth by the Accounting Standards Board and deemed to be more accurate rather than making and functioning on the financial statements over cash basis.
Disadvantages of Accrual Accounting
There are some accounting methods and cause of disadvantages using accrual method of accounting, that revolve around the staff members needed to maintain the system:
- Small companies might lack the staff needed to manage this method. The big corporations or big organizations have an entire department which has been dedicated to work on the tracking and reporting transactions. For an outsourcing company, the accounts receivables department to keep track of the invoices and the accounts payable department team need to look after the expenses and liabilities of the company.
- Accrual basis accounting requires at least monthly reporting. In order to remain accurate, accrual accounting needs frequent reports generated. It includes the income statement, balance sheet and the monthly reports that the business managers have been most familiar with.
- Taxes. Although an advantage to using accrual accounting is that you can report income when the sale is incurred instead of waiting until you have cash on hand, this also means a business pays taxes on money it hasn't received.
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