Accrual Basis Vs. Cash Basis Accounting

Accrual Basis vs. Cash Basis Accounting

Cash basis and accrual basis accounting are the two principle accounting methods for keeping track of a business's income and expenses (Fishman, 2012). According to the cash basis method, the income is not recorded until actual cash or payment is received. Likewise, the expenses are also not recorded until they are actually paid for. According to the accrual basis method transactions are recorded as soon as the order is made or the services occur regardless if payment is actually received. The main difference between the two is the timing of when transactions are debited and credited to accounts. However, there is certain criteria to be aware of when choosing an accounting method. As previously noted, most small businesses use cash basis accounting and that is because most small businesses with sales of less than $5 million per year are free to adopt either accounting method. The same is not so when deciding whether or not to use the accrual method. The accrual method must be used if the business has sales of more than $5 million per year or if the business stocks an inventory of items that will be sold to the public and the gross receipts are over $1 million per year.

Commercial accounting and GAAP generally prescribe accrual basis of accounting based on its benefits. As previously mentioned, because of certain guidelines sometimes accrual basis accounting is the only option. However, regardless if whether or not accrual basis is chosen or necessary the benefits are present nonetheless and for that reason it is generally prescribed. Benefits of accrual basis accounting are the following: equal distribution of expenses paid in advance and equal distribution of expenses paid in arrears (Morris, 2012). Cash basis accounting is beneficial to smaller companies especially if most of the sales are cash sales, the company does not have to maintain an inventory and there are no customer accounts of returns. Cash basis accounting is typically much easier and much cheaper to maintain (Moneyinstructor.com, 2012). While there are benefits to both methods the choice between them should be made based off the earnings of the business.