Cash-Basis vs Accrual Accounting
Cash-Basis vs Accrual Accounting – Essential Aspects to Consider Before Choosing
Accounting is an essential aspect of any business. There are primarily three methods of accounting – Cash-basis, accrual accounting and modified cash-basis, and each method has its pros and cons in application. The two accounting methods that have a major difference in their implementation are Cash-basis account and Accrual accounting outsourcing. The fundamental difference between these depends on the timing of when revenue and expenses are recorded in your account. After weighing their pros and cons against each other, you can determine which method is best suited for your business’ accounting needs.
Cash-Basis Accounting vs Accrual Accounting
Let us explore how cash-basis accounting differs from accrual accounting.
It is the simplest method of accounting used by small businesses for book-keeping. In this method, a business can only use cash accounts to record expenses and income. It simply means that the income is recorded only when you receive cash from the customers and expenses are recorded only after you pay cash.
Advantages of Cash-Basis Accounting:
- Less expensive in comparison with other methods
- Easy to use
- Does not require a deep knowledge of accounting
- Easy maintenance
- Limited information to audit
- Advantageous for small business
Disadvantages of Cash-Basis Accounting:
- Cannot track long-term liabilities like loan or inventory
- Inaccurate representation of cash-rich companies with a large sum of liabilities to be paid
- Only cash accounts can be tracked
- Not ideal for large business as it has a restricted use
The balance sheet for Cash-basis accounting only includes assets, liabilities and equity but doesn’t include payable accounts, receivable accounts or inventory. This shows us that cash-basis accounting doesn’t inform us about unpaid invoices and expenses.
Given below is an example of a Cash-basis accounting balance sheet:
|Asset Account||Subaccount type||Balance|
|Liability Account||Subaccount Type||Balance|
|Sales Tax collected||Sales Tax payable||$1400.00|
|Equity Account||Subaccount Type||Balance|
Accrual accounting is a complex method of accounting which requires a deep knowledge of the subject for implementation. Accrual accounting considers advanced accounts such as payable accounts, current assets, inventory and long-term liabilities. It records income when a transaction has taken place irrespective of whether the amount is paid yet. It also records expenses when you are billed.
Advantages of Accrual Accounting:
- Forecasting future income and expense
- Accurate representation of the company’s financial performance
- Projecting long-term profitability
- Making financial strategies based on projected income and expense
- Accessing various accounts for transactions
Disadvantages of Accrual Accounting:
- More complex in its implementation
- Requires deep knowledge of accounting
After implementing accrual accounting, your company’s balance sheet will contain more details of your liabilities and transactions.
Given Below is an example of accrual account balance sheet
|Asset Account||Sub-account type||Balance|
|Account receivable||Accounts receivable||$2000.00|
|Liability Account||Sub-account type||Balance|
|Accounts payable||Accounts payable||$0.00|
|Sales Tax Collected||Sales Tax payable||$1400.00|
|Credit Memo Liability||Current liabilities||$0.00|
|Payroll Tax Liability||Current liabilities||$0.00|
|Equity Account||Sub-account type||Balance|
Tabular Comparison Between Cash-Basis Accounting and Accrual Accounting
Given below is a table that explains how different accounts are reviewed in the methods mentioned above
|Type of account||Cash basis||Accrual basis|
|Cost of goods sold||Yes||Yes|
|Long term liabilities||—-||Yes|
It can be inferred from the information given above that ideally, cash-basis accounting is implemented by small businesses to maintain their books and Accrual accounting is implemented by large or publicly traded companies for their accounting purposes. Cash-basis accounting is a simple and easy-to-use method that only records cash after the transaction is completed and cannot be used to record long-term liabilities, expense and inventory.
Accrual accounting is a complex method that requires a deep knowledge of accounting and also gives an accurate representation of the company’s financial performance. Depending on the nature of your business, and after going through every aspect of the methods above, the accounting method best suited is chosen.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.