Do you know the difference?
The key difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized.
The cash method is a more an immediate recognition of revenue and expenses, while the accrual method focuses on anticipated revenue and expenses.
Over time the results of the two methods are approximately the same. The timing difference between the two methods occurs because revenue recognition is delayed under the cash basis until customer’s payments are received by business. Similarly, the recognition of expenses under the cash basis can be delayed until such time as a supplier invoice is paid.
Usage of the Cash Basis and Accrual Basis
The cash basis is only available for use if a business generates under $5 million in sales per year. It is easiest to account for transactions using the cash basis, since no complex accounting transactions such as accruals and deferrals are needed. The cash basis is widely used in small business thanks to its ease of use. However, the relatively random timing of receiving cash and expenditures means that results reported can bounce between unusually high and low profits. This method is also commonly used by individuals when tracking personal finances.
The accrual basis is used by all larger companies, for numerous reasons. First, its use is required for tax reporting when sales exceed $5 million and a company’s financial statements can only be audited if they have been prepared using this method. Additionally, the financial results of a business under the accrual basis are more likely to match revenues and expenses in the same reporting period, so the profitability of an organization can be uncovered with greater accuracy. However, unless a statement of cash flows is included in the financial statements, this approach does not reveal the ability of a business to generate cash.
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