Accrual Basis Accounting vs. Cash Basis Accounting

Business owners and managers sometimes ask the accrual basis accounting vs. cash basis accounting question. Or, restated in a slightly different form: Should a firm be using accrual basis accounting or cash basis accounting?

Cash Basis Accounting Defined

Cash basis accounting counts revenue when the firm receives money (cash, checks, and so on) from customers. Cash basis accounting counts expenses when the firm spends money to pay bills. The convenient thing about cash basis accounting is that cash basis accounting is very easy to implement. But, unfortunately, cash basis accounting doesn’t measure profits very accurately. As a result, sometimes cash basis accounting doesn’t give businesses the financial information needed to manage the operation.

Accrual Basis Accounting Defined

Accrual basis accounting counts revenue when the firm earns the revenue (typically this means at the time the customer or client is invoiced). Accrual basis accounting counts expenses when the firm incurs the cost (such as when a firm actually receives some item or service from a vendor). The neat thing about accrual basis accounting is that it usually produces much better estimates of a firm’s profits. Unfortunately, accrual basis accounting requires significantly more bookkeeping work.

Choosing Accrual Basis Accounting vs Cash Basis Accounting

If you’re trying to choose between accrual basis accounting or cash basis accounting, here are some suggestions:

1. Start with cash basis accounting first. Cash basis accounting may provide you with the information you need to run your business-and that’ll mean you can simplify your accounting and bookkeeping.
2. If you find cash basis accounting doesn’t work, you can later convert to accrual basis accounting for financial accounting purposes. (This may mean you need to upgrade your accounting system-such as from Quicken to QuickBooks. This may also mean that you need to change your bookkeeping practices so that you count revenues when they are earned and count expenses when they’re incurred.)
3. Remember that just because you change from cash basis accounting to accrual basis accounting for financial accounting purposes, that doesn’t mean you should convert from cash basis accounting to accrual basis accounting for tax accounting. In fact, typically, businesses want to use cash accounting for tax reporting if they can, because cash accounting usually defers income taxes.

If you need help answering the accrual basis accounting vs. cash basis accounting question, please consider contacting us to set up an appointment.