Cash basis and accrual basis Accounting Methods – Difference between Cash and Accrual Accounting methods

The cash and accrual methods are two principal criteria of keeping track of income and expenses in a business, therefore facilitating decision making particularly in accounting and payment of taxes.  Ordinarily business people are advised to learn how each of the methods work, the merits and demerits and hence be in a position to select a better option for their businesses.

The cash method is more effective for business people interested mainly in small businesses. Under this criterion, the expenses are not counted until they are essentially paid, and income is not counted until the check or cash is actually received.

For example, if I have to order stationery and business cards for a small business I opened, and pay the invoice on November 26, 2008 after I receive the products; I am allowed under the cash system to deduct the cost on my tax returns for the same year.

In some cases, corporations that have with gross revenue more than $5 million, for any particular year, are not allowed to use the cash method.  Farming corporations are allowed to use the method but only if their gross revenues are less than $25 million, while Professional Service Corporations can use it without any limits.  Tax shelters are not allowed to use the cash method.

The accrual method is multifaceted. More focus is placed on dates when the expenses are incurred and not when it is paid, as in the case of the cash method.  Although this may seem a negligible difference it can cause confusion in balancing books of accounts or when making decisions. The accrual method is a poor means of tracking cash but it is a great criterion for matching expenses and revenues in businesses.  This is because the user is only allowed to record revenue when the transaction occurs as opposed when the cash is collected.  This may present a scenario whereby one can end up with lots of revenue but little cash, if customers are slow to pay.

Using the earlier example, if I order stationery and business cards on December 21, 2008 and receive the products on December 29, but wait till January 22, to pay the invoice;  it becomes difficult to tell when the expense will be claimed-it will mainly depend on when the economic performance occurs. This usually takes place when the goods or services are delivered or provided to you. In this case the economic performance will possibly occur when the items are delivered with the invoice on December 29. I would therefore be able to deduct the expense for the 2008 tax year.

The cash method is a simpler and straightforward accounting method. However, it is recommended that you consult a tax professional for advice on the best method for your business.

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