Cash-Basis vs Accrual Accounting

Choosing Between Cash Basis and Accrual Accounting

Accounting is an essential aspect of any business. There are three main methods of accounting:

Cash basis

Accrual accounting

Modified cash basis

Each method has its pros and cons when applied.

The two accounting methods that have a major difference in their implementation are cash basis accounting and accrual accounting.

The fundamental difference between these depends on the timing of when revenue and expenses are recorded in the accounts.

After weighing their pros and cons, you can determine which method is best suited for your company's accounting needs.

Cash Basis Accounting

Cash basis accounting is the simplest method of accounting. It is commonly used by small businesses for bookkeeping purposes.

In cash basis accounting, a business only uses cash accounts to record expenses and income. This simply means that income is recorded only when you receive cash from customers; expenses are recorded only after you pay cash.

Advantages of Cash Basis Accounting

Less expensive compared to other methods

Easy to use

Does not require a deep knowledge of accounting

Easy maintenance

Limited information to audit

Advantageous for small businesses

Disadvantages of Cash Basis Accounting

Cannot track long-term liabilities such as loans or inventory

Inaccurate representation of cash-rich companies with large liabilities

Only cash accounts can be tracked

Not ideal for large businesses as it has a restricted use

The balance sheet for cash basis accounting only includes assets, liabilities, and equity. It doesn’t include payable accounts, receivable accounts, or inventory.

As such, 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	Sub Account Type	Balance
Checking	Bank account	$6,000.00
Savings	Bank account	$3,000.00
Petty cash	Cash	$2,000.00
Total assets		$11,000.00

Liability Account	Sub Account Type	Balance
Sales tax collected	Sales tax payable	$1,400.00
Total liabilities		$1,400.00

Equity Account	Sub Account Type	Balance
Owner’s equity	Equity	$600.00
Net income		$9,000.00
Total equity		$9,600.00

Accrual Accounting

Accrual accounting is a complex method of accounting that depends on having a deep knowledge of the subject.

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.

Under an accrual accounting system, expenses are also recorded when you are billed.

Advantages of Accrual Accounting

Useful for forecasting future income and expenses

Accurate representation of the company’s financial performance

Projecting long-term profitability

Making financial strategies based on projected income and expenses

Accessing different accounts to learn about transactions

Disadvantages of Accrual Accounting

Complex to implement

Requires deep knowledge of accounting

After implementing an accrual accounting system, your company’s balance sheet will contain significantly more detail about your liabilities and transactions compared to cash basis accounting.

Given below is an example of a balance sheet under the accrual accounting system.

Asset Account	Sub Account Type	Balance
Checking	Bank account	$6,000.00
Saving	Bank account	$3,000.00
Petty cash	Cash	$2,000.00
Accounts receivable	Accounts receivable	$2,000.00
Total Assets		$13,000.00

Liability Account	Sub Account Type	Balance
Accounts payable	Accounts payable	$0.00
Sales tax collected	Sales tax payable	$1,400.00
Credit memo liability	Current liabilities	$0.00
Payroll tax liability	Current liabilities	$0.00
Total liabilities		$1,400.00

Equity Account	Sub Account Type	Balance
Owner’s equity	Equity	$600.00
Net income		$10,000.00
Total equity		$10,600.00

Tabular Comparison of Cash Basis Accounting and Accrual Accounting

The table below summarizes how different types of accounts are reviewed under cash basis and accrual accounting.

Type of Account	Cash Basis	Accrual Basis
Cash	Yes	Yes
Equity	Yes	Yes
Income	Yes	Yes
Cost of goods sold	Yes	Yes
Expense	Yes	Yes
Accounts receivable	----	Yes
Fixed assets	----	Yes
Current assets	----	Yes
Accounts payable	----	Yes
Long-term liabilities	----	Yes
Current liabilities	----	Yes

Conclusion

Ideally, cash basis accounting should be implemented by small businesses and accrual accounting should be used in large or publicly traded companies.

Cash basis accounting is simple and easy to use. It only records cash after transactions are completed and it cannot be used to record long-term liabilities, expenses, and inventory.

Accrual accounting is a complex method that involves sophisticated techniques. It yields a more accurate representation of the company’s financial performance compared to cash basis accounting.

Depending on the nature of your business, and after considering each aspect of the methods described above, you should be able to choose the best-suited approach.

Cash-Basis vs Accrual Accounting FAQs

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts