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Accrual Accounting vs Cash Accounting methods are like two sides of a coin. In the long term, they don’t affect much, but in the short term can provide huge differences to the statement of cash flows.Accrual Accounting vs Cash Accounting Infographics
Below is the top 7 difference between Accrual Accounting vs Cash Accounting.Key Differences Between Accrual Accounting vs Cash Accounting Nature
Cash accounting is simple and intuitive to understand. Income and expenditure are realized based on their occurrence. Therefore, it did not matter when the invoice was issued. Hence when a firm relies on cash-based accounting, it does not need to prepare any adjustment entries like accruals, deferrals, or prior period items.Meeting GAAP
The cash accounting method places greater reliance on the timing of payments rather than when they were incurred. As a result, it is possible for a firm not to record revenue in the year when the corresponding work was performed, as the revenue was received a year later. As a result, it is not an acceptable form of accounting, and hence it is not recognized by GAAP (Generally Accepted Accounting Principles). On the other hand, Accrual accounting is widely accepted because it recognizes the revenues when earned rather than when received.A Better Picture of Financial Performance Access to Credit
As a result, there will be times when payments will be delayed. Recording and measuring credit can be easily done in accrual accounting, a phenomenon unknown in cash accounting.Tax Implications
Whether you use the accrual or cash mechanism of accounting, it can substantially impact your tax statements. For example, say you receive a payment in January (start of the fiscal year) for the services provided in Q4 (end of the previous fiscal year) of $ 5000. Cash accounting would include this amount as revenue in the current fiscal year, inflating your tax for the current year. However, accrual accounting would consider this amount in the previous fiscal year itself even though the payment was not received.Accrual Accounting vs Cash Accounting Comparison Table
Below Is The Topmost Comparison Between Accrual Accounting vs Cash Accounting
Basis of comparison Cash Accounting Accrual Accounting
Meaning The recognition of revenues and expenses only happens when the company receives payments or pays bills In the accrual method, the company recognizes revenue and expenses as and when they incur them.
Mechanism includes payments received and expenses paid only through cash Considers all types of expenses irrespective of the method in which the payment is made, like credit.
Nature Simple and intuitive Complex and difficult to understand
Recognized by GAAP does not recognize Cash Accounting GAAP and the company’s act recognize accrual accounting.
Basis of accounting Whenever there is a cash-based transaction Depends more on revenue and expenses rather than the transactions.
Usefulness Provide an excellent picture of cash flows It matches revenue and expenses perfectly, although bad at tracking cash flows.
Holistic approach No, as the emphasis is more on transactions. It provides a holistic view of all types of Accounts receivable and Accounts payable.Conclusion
For its simplicity, easy implementation, less time-consuming, and easier interpretation, Cash accounting is acceptable for small enterprises (having less than $ 5 million in sales). This method allows one to easily account for the payments and avoid complex accounting mechanisms like deferrals and accruals. However, since there is too much dependence on the transactions, a single payment from the client can result in unusually high or low profits in a particular quarter because of its sheer size or random timing. This very nature makes cash accounting difficult for publicly traded companies. However, as the firm’s size becomes large and transactions based on credit increase, accrual accounting is no longer an option but a necessity. Hence, it would be in the interest of SMEs and managers anticipating future growth to understand it to smooth the transition.Recommended Articles
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