Accrual to Cash Conversion

Most financial statements are prepared under the accruals basis of accounting as required by GAAP, however, there are occasions when information is required on a cash receipts and payments basis. In these circumstances the accrual to cash conversion process is used to convert between the two systems.

Under the accruals basis of accounting revenue is recorded when earned and expenses are recorded when incurred. In contrast, under the cash basis of accounting revenue is recorded when cash is received, and expenses are recorded when cash is paid.

This is summarized in the table below.

Accrual to cash conversion
Accruals Cash
Revenue Earned Received
Expenses Incurred Paid

Accrual to Cash Example

If a business has maintained it’s bookkeeping records on an accruals basis, at the end of the accounting period the balances on each ledger account will reflect revenue earned and expenses incurred during the period.

It should be noted that the calculation of cash receipts and payments is normally done for information purposes only, and that accrual to cash conversion journal entries are not normally posted into the accounting records, unless there is a need to permanently change the basis of accounting.

To calculate cash receipts and payments the business will need to adjust the balances from each revenue and expense account to reflect the accrual to cash conversion.

Accrual to Cash Conversion Formula

In general the following accrual to cash conversion formulas can be used to convert each revenue and expense income statement account from the accrual basis to the cash basis of accounting.

In each formula the terms used have the following meanings.

  • AR = Accounts receivable
  • AP = Inventory accounts payable
  • AE = Accrued expenses payable
  • Revenue, expenses, purchases, inventory, and cost of goods sold are on an accruals basis.

Calculating Revenue Cash Receipts

The revenue cash receipts is given by the following accrual to cash conversion formula.

Receipts = Revenue + Beginning AR – Ending AR

Suppose for example the revenue earned by a business is 7,600 and the balance on the accounts receivable account at the beginning of the year is 9,000, and at the end of the year is 12,000.

The revenue cash receipts for the year is calculated using the formula as follows.

Revenue = 7,600
Beginning accounts receivable = 9,000
Ending accounts receivable = 12,000
Receipts = Revenue + Beginning AR - Ending AR
Receipts = 7,600 + 9,000 - 12,000 = 4,600 

Cash receipts from sales are lower than the revenue earned due to the increase in accounts receivable of 3,000.

Calculating Expense Cash Payments

The expense cash payments are given by the following accrual to cash conversion formula.

Payments = Expenses + Beginning AE – Ending AE

If a business has expenses incurred of 13,200 for the year and the beginning balance on accrued expenses payable is 2,000, and at the end of the year is 5,000, then the expense cash payments can be calculated using the formula as follows.

Expenses = 13,200
Beginning accrued expenses payable = 2,000
Ending accrued expenses payable = 5,000
Payments = Expenses + Beginning AE - Ending AE
Payments = 13,200 + 2,000 - 5,000 = 10,200

The expense cash payments are lower than the expenses incurred due to the increase in accrued expenses payable.

Other Useful Accrual to Cash Conversion Formulas

The formulas used above deal with the most frequently encountered situations when converting accruals based revenue and expenses to cash receipts and payments.

The accrual to cash basis conversion formulas below allow for additional complications where the business has for example to deal with unearned revenue, prepaid expenses, and inventory.

In each case the formula shows how to calculate cash receipts and payments using information from an accruals based accounting system.

1. Revenue Accrual to Cash Conversion – Adjusting for Unearned Revenue

Receipts = Revenue + Beginning AR – Ending AR + Ending unearned revenue – Beginning unearned revenue

2. Revenue Accrual to Cash Conversion – Adjusting for Accounts Receivable Written Off

Receipts = Revenue + Beginning AR – Ending AR – AR written off

3. Expenses Accrual to Cash Conversion – Adjusting for Prepayments

Payments = Expenses + Beginning AE – Ending AE + Ending prepayments – Beginning prepayments

4. Purchases Accrual to Cash Conversion

Payments = Purchases + Beginning AP – Ending AP

5. Cost of Goods Sold Accrual to Cash Conversion

Payments = Cost of goods sold + Beginning AP – Ending AP + Ending inventory – Beginning inventory
Accrual to Cash Conversion May 16th, 2017Team

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