Accrual accounting and cash accounting are two main methods of accounting. The underlying difference between Cash vs. Accrual Accounting is the timing of which the income and expenses are recorded in the books of account.
In cash accounting method, the items are recorded when the actual cash transactions are made, irrespective of when the income is earned or expense incurred. Thus, if your company has delivered a product or a service to one of your clients and you operate with a 30-days credit period i.e., you will be getting paid for your delivery after 30 days of your delivery. As per cash accounting, you will record the income from this delivery only once you receive the payment from your client, whether it’s before 30 days or after. On the other hand, in accrual accounting method, the items are recorded when you provide or receive a service or a product, even before the actual cash transactions are made. Accrual accounting method is a more commonly used method. So in the above case, you will record the income as soon as you have shipped the product or rendered the service.
It is the firm’s discretion to use the method which it deems suitable, as long as it is consistent with maintaining the accounts. Generally, small businesses opt for cash basis of accounting whereas larger firms go for accrual accounting.
Difference Between Cash Vs. Accrual Accounting
|Time Frame||Revenue and expenses are recorded when the money is debited or credited.||Revenue and expenses are recorded as soon as the service is rendered or used.|
|Accuracy||This can be misleading because the time you receive money may be much later than the time you rendered the service. It has a very narrow view of business and there is no control on complex non-cash transactions.||This is a more accurate form of representation and gives a real picture of the position of the business.|
|Ease Of Use||This is easier to maintain. Requires fewer journal entries as compared to Accrual accounting.||It is difficult to maintain as transactions need to be recorded as they happen. This requires a lot more journal entries than cost accounting.|
|Cash Flow||Cash accounting gives an accurate representation of cash going in and out of the system.||Accrual accounting doesn’t give a correct representation of cash. As a result, managers have to maintain separate cash flow statements, which is an overhead.|
|Trend Analysis||Since the transactions are recorded only when the cash changes hands, there may be a significant time gap between even occurrence and its recording. Hence, trend analysis may not be possible.||Since transactions are recorded as they occur, there is an accurate representation of when the transaction has happened. Thus, it is easier to analyze the sales or expense patterns.|
Other Important Differences are as follows:
|Industry Specific||This method is not a preferred method of accounting for businesses which have a big gestation period and huge capital involved; e.g., construction, real estate. The method is followed generally by small businesses.||This is a preferred method of accounting for businesses which have a big gestation period and huge capital involved.|
|GAAP accepted||Cash accounting method is not a GAAP approved method of accounting.||This method is approved by GAAP (Generally Accepted Accounting Principles.|
|Taxation||Since the transaction is recorded only when actual cash inflow or outflow is involved, tax liability may be lower at times. However, the method has its shortcomings and is not flexible for reporting for taxation purpose.||Accrual accounting, for its accuracy, is apt for reporting for taxation purpose.|
Which Method Should Be Used – Cash vs. Accrual Accounting
Each of the accounting methods has its own benefits and shortcomings. If you have a small business or a business type where cash is exchanged almost instantaneously, you can opt for cash accounting because of its ease of use.
On the other hand, if you have a huge business turnover where involving complex transactions like loans, repayments, inventory, creditors, reserves, accounts receivable etc. you are better off using the accrual basis of accounting. This method is considered to show a better picture of business profitability and its operations.