Accrual and cash are the two most common methods of maintaining the books and
records of your business. If your business is a sizeable company, your lenders
or investors may require you to use the accrual method.
The accrual
method requires that you record business activity when it occurs not necessarily
when money changes hands as in the cash basis. For example, if your business
provides entertainers for children’s birthday parties, under the cash method you
would record income only when you receive the cash. Under the accrual method,
you would record income when the work that you were contracted to provide is
completed and the obligation exists for your customer to pay you. For another
example, if you ordered office supplies, under the accrual method you would
record the expense as soon as the supplies were received even if you hadn’t paid
for them yet. Under the cash method, you would record the expense only when you
write the check to pay the vendor for the office supplies.
As you may
have guessed, the cash method requires fewer bookkeeping entries and for this
reason many small businesses prefer this method. The cash method does not
adequately account for transactions that are in process or partially complete,
and for this reason, larger or more complicated businesses may prefer the
accrual method.
Both of these methods are acceptable for financial
statements and for preparing your tax return in most cases. If your business has
inventory, you must use the accrual method of accounting for your taxes. If your
business is a C corp. or a partnership that has a C corp. as a partner you must
use the accrual method. There are certain exceptions to this rule for small
companies.
Remember that regardless of which accounting method you use,
you must use it consistently.