Cash Basis Versus Accrual Basis Accounting

There are two methods of accounting and financial statement preparation, “cash basis” and “accrual basis.”  Cash basis accounting does not use accounts receivable and accounts payable; instead, income is booked when cash is actually received, and expenses are booked when checks are written.  Many small businesses use cash basis accounting, because it is easier to perform, and it involves fewer entries and less bookkeeping.  Many businesses also use the cash basis for their income tax returns.  It can minimize taxable income, since sales are not booked until payment is received.

Virtually all big businesses use accrual accounting (including accounts receivable and accounts payable) for their financial reporting.  Accrual accounting is beneficial because of the “matching” principle.  The use of accrual accounting allows revenues to be matched with corresponding expenses that are incurred in the same period (without regard for when the cash actually comes in or goes out the door.)  This often allows financial statement analysis to be more meaningful (for both the company and outside analysts.)

Accrual accounting can be easily converted to cash basis accounting; in fact, most accounting programs allow you to choose to create either cash or accrual reports.  But, conversely, cash accounting cannot be converted to accrual accounting without the receipt of additional information.