Accrual vs Cash

Accrual Basis Vs. Cash Basis Accounting Methods

ACC 290

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May 14, 2012

Dr. ***

Accrual Basis Vs. Cash Basis Accounting Methods

The accrual basis of accounting means that transactions are recorded when the transaction occurs regardless of when the cash is received or paid. When a sale occurs the income is recorded, even if the cash payment is not received until a later date. Similarly, when products such as office furniture or equipment are purchased the expense is recorded, even if the item(s) is not paid off until a later date.

The cash basis of accounting means that transactions are recorded when the cash is either paid or received regardless of when the transaction took place. Using this method of accounting, if a company pre-paid for insurance the cash expense would be recorded when the payment was made. If a company completed a job in May but didn't receive payment for the job until July, the income would be recorded in July when the cash payment was received.

There are pros and cons to both methods of accounting. According to Stephen Fishman, "while the accrual method shows the ebb and flow of business income and debts more accurately, it may leave you in the dark as to what cash reserves are available, which could result in a serious cash flow problem" (2012). For example, the income ledger could show significant increases in sales without showing the real picture because customers have not yet paid. In contrast, the cash basis can provide a clearer picture of cash on hand but can be misleading in terms of long-term profitability.

Because of the pros and cons to both accounting methods businesses will prefer one or the other based on their size, inventory, sales, and other pertinent factors. Small businesses tend to prefer the cash basis because of their relatively low cash-on-hand and the need to have a clear picture of the up-to-date books. Larger organizations generally utilize the accrual basis because of large inventory,...