Cash vs Accrual Accounting

Cash vs accrual basis of accounting are two methods of recording transactions for a business.

Under the cash basis, transactions are recorded when cash is received or paid, under the accrual basis revenue is recorded when earned and expenses are recorded when incurred.

The accrual method is the preferred method as it complies with the matching principle in accordance with generally accepted accounting standards which ensures that expenses are matched revenues.

Cash vs Accrual Comparison – Payments

Cash Accounting Method

Under the cash basis of accounting no record is made at the date of the purchase as the cash is not paid until the 30 days credit period has expired (20 January 2019).

When the cash is paid the following entry is recorded.

Accrual Accounting Method

Under the accrual basis of accounting, the transaction is recorded when the purchase is made. As no cash is paid at this point, the credit entry goes to the accounts payable account, representing money owed to the supplier.

After 30 days the supplier is paid, the following entry is recorded.

In the above case after 30 days the net effect of both the accrual basis entries is to debit purchases and credit cash, the same as the cash basis of accounting.

Cash vs Accrual Comparison – Receipts

Assume the business now sells the product on the 20 December 2018 to customers on 30 day credit terms for 200.

Cash Accounting Method

Under the cash basis of accounting no record is made at the date of the sale as the cash is not received until the 30 days credit period has expired (20 January 2019).

When the cash is received the following entry is recorded.

Accrual Accounting Method

Under the accrual basis of accounting, the transaction is recorded when the revenue is earned (when the sale is made). As no cash is received at this point, the debit entry goes to the accounts receivable account, representing money due from the customer.

After 30 days the customer pays and the cash is received, the following entry is recorded.

In the above case after 30 days the net effect of both the accrual basis entries is to debit cash and credit sales, the same as the cash basis of accounting.

Income Statement

The income statement for the business is produced at the end of the month 31 December 2018.

Accrual Accounting Method

Using the accruals accounting method the transactions are recorded when the purchase or sale takes place (20 December 2018) and therefore at the month end (30 December) both transactions have been recorded in the accounting records.

Assuming there is no change in inventory the income statement will be as follows.

In the following month the cash receipts and payments are recorded in the accounting records and affect only accounts receivable and payable which are both balance sheet accounts.

Assuming there are no additional sales and purchases transactions an income statement produced at the end of January would show a net income of zero as follows.

Cash Accounting Method

Using the cash accounting method the business only records cash receipts and payments. Since the cash payment and cash receipt did not occur until 20 January 2019 there are no transactions recorded in the accounting records and the business shows a net income for the month ended December 2018 of zero.

In the following month the cash receipts and payments are recorded in the accounting records and an income statement produced at the end of January would appear as follows.