Cash-Basis vs Accrual Accounting

Cash-Basis v/s 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 v/s Accrual accounting

Let us explore how cash basis accounting differs from accrual accounting.

Cash Basis 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.

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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 AccountSubaccount typeBalance
CheckingBank account$6000.00
SavingsBank account$3000.00
Petty CashCash$2000.00
Total Assets $11,0000.00

 

Liability AccountSubaccount TypeBalance
Sales Tax collectedSales Tax payable$1400.00
Total liabilities $1400.00

 

Equity AccountSubaccount TypeBalance
Owner’s equityEquity$600.00
Net income $9000.00
Total equity $9600.00

Accrual Accounting:

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.

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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 AccountSub-account typeBalance
CheckingBank account$6000.00
SavingBank account$3000.00
Petty cashcash$2000.00
Account receivableAccounts receivable$2000.00
Total Assets $13000.00

 

Liability AccountSub-account typeBalance
Accounts payableAccounts payable$0.00
Sales Tax CollectedSales Tax payable$1400.00
Credit Memo LiabilityCurrent liabilities$0.00
Payroll Tax LiabilityCurrent liabilities$0.00
Total Liabilities $1400.00

 

Equity AccountSub-account typeBalance
Owner’s equityequity$600.00
Net income $10000.00
Total equity $10600.00

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 accountCash basisAccrual basis
CashYesYes
EquityYesYes
IncomeYesYes
Cost of goods soldYesYes
ExpenseYesYes
Accounts receivable—-Yes
Fixed Assets—-Yes
Current Assets—-Yes
Accounts payable—-Yes
Long term liabilities—-Yes
Current liabilities—-Yes
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Conclusion

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.

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