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Accrual Accounting vs. Cash

Basis Accounting: What's the
Table of Contents
Difference?
Overview By CHIZOBA MORAH Updated May 06, 2022

Accrual Accounting Reviewed by ANDY SMITH

Fact checked by SUZANNE KVILHAUG
Cash Basis Accounting

Key Differences Accrual Accounting vs. Cash Basis Accounting: An

Special Considerations Overview
Example The main difference between accrual and cash basis accounting lies in the
timing of when revenue and expenses are recognized. The cash method
Accounting Method FAQs
provides an immediate recognition of revenue and expenses, while the accrual
method focuses on anticipated revenue and expenses.

KEY TAKEAWAYS
Accrual accounting records revenue and expenses when transactions
occur but before money is received or dispensed.
Cash basis accounting records revenue and expenses when cash
related to those transactions actually is received or dispensed.
Accrual accounting provides a more accurate view of a company's
health by including accounts payable and accounts receivable.
The accrual method is the more commonly used method by large
companies, especially by publicly-traded companies, as it smooths out
earnings over time.
The cash basis method typically is used by sole proprietors and
smaller businesses.

Accrual Accounting
Under this method, revenue is accounted for when it is earned. Unlike the cash
method, the accrual method records revenue when a product or service is
delivered to a customer with the expectation that money will be paid in the
future. In other words, money is accounted for before it's received. Likewise,
expenses for goods and services are recorded before any cash is paid out for
them. Advertisement

Cash Basis Accounting

Under this method, revenue is reported on the income statement only when
cash is received. Expenses are recorded only when cash is paid out. The cash
method is typically used by small businesses and for personal finances.

Key Differences
Accrual Method
The accrual method records accounts receivables and payables and, as a
result, can provide a more accurate picture of the profitability of a
company, particularly in the long term.

For example, a company might have sales in the current quarter that wouldn't
be recorded under the cash method. The related revenue is expected in the
following quarter. An investor might think the company is unprofitable when,
in reality, the company is doing well.  

The accrual method doesn't track cash flow. A company might look profitable
in the long term but actually have a challenging, major cash shortage in the
short term.

Another disadvantage of the accrual method is that it can be more complicated

to use since it's necessary to account for items like unearned revenue and
prepaid expenses. It also may require added staff.

The accrual method typically is required for companies that file audited
financial statements and is accepted under the generally accepted accounting
principles (GAAP) issued by the Financial Accounting Standards Boards (FASB).

Cash Basis Method

The key advantage of the cash method is its simplicity—it only accounts for
cash paid or received. Tracking the cash flow of a company is also easier.

It's beneficial to sole proprietorships and small businesses because, most

likely, it won't require added staff (and the related expenses) to use.

However, the cash basis method might overstate the health of a company that
is cash-rich. That's because it doesn't record accounts payables that might
exceed the cash on the books and the company's current revenue stream. 

As a result, an investor might conclude the company is making a profit when, in

reality, the company might be facing financial difficulties.

The cash basis method is not acceptable under GAAP.

Tax Law Change

The Tax Cuts and Jobs Act increased the number of small business
taxpayers who were entitled to use the cash basis accounting
method. As of January 2018, small business taxpayers with average
annual gross receipts of $25 million or less in the prior three-year
period could use it. [1]

Special Considerations
The accrual method is the more commonly used method, particularly by
publicly-traded companies. One reason for the accrual method's popularity is
that it smooths out earnings over time since it accounts for all revenues and
expenses as they're generated. The cash basis method records these only when
cash changes hands and can present more frequently changing views of
profitability.

For example, under the cash basis method, retailers would look extremely
profitable in Q4 as consumers buy for the holiday season. However, they'd look
unprofitable in the next year's Q1 as consumer spending declines following the
holiday rush.

Both methods have their advantages and disadvantages. Each provides

different views of the financial health of a company. For investors, it's
important to understand the impact of both methods when making investment
decisions. 

Accrual Accounting vs. Cash Basis Accounting

Example
Let's say you own a business that sells machinery. If you sell $5,000 worth of
machinery, under the cash method, that amount is not recorded in the books
until the customer hands you the money or you receive the check.

Under the accrual method, the $5,000 is recorded as revenue as of the day the
sale was made, though you may receive the money a few days, weeks, or even
months later.

The same principle applies to expenses. If the company receives an electric bill

for $1,700, under the cash method, the amount is not recorded until the
company actually pays the bill. However, under the accrual method, the $1,700
is recorded as an expense the day the company receives the bill.

What Is Accrual Accounting?

Accrual accounting is an accounting method that records revenues and
expenses before payments are received or issued. In other words, it records
revenue when a sales transaction occurs. It records expenses when a
transaction for the purchase of goods or services occurs.

What Is the Difference Between Cash and Accrual

Accounting?
Cash basis accounting records revenue and expenses when actual payments
are received or disbursed. It doesn't account for either when the transactions
that create them occur. On the other hand, accrual accounting records revenue
and expenses when those transactions occur and before any money is received
or paid out.

When Does a Company Account for Revenue If It

Uses Cash Basis Accounting?
Under the cash basis accounting method, a company accounts for revenue only
when it receives payment for the products or service it provided a customer.

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