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What is the Difference Between Accrual and Cash Accounting?

Apr 05, 2009

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.

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