Cash vs Accrual Accounting: What’s the Difference? 

One of the most used methods of bookkeeping is the cash basis or the accrual basis method in terms of tracing revenue and expenses. However, depending on the nature of your business, one of these approaches may be more suitable. You will have to find out what the most suitable method in bookkeeping is and also check whether the model used is appropriate for the government.

What is Cash and Accrual Accounting?

The point at which income and costs are recorded in the books is the main difference between accrual and cash accounting.

Cash accounting keeps records of revenues as soon as money is received and expenses as soon as money is spent. Revenue is recorded when it is received, and costs are recorded when they are incurred in accrual accounting.

Therefore, accrual accounting records payables and receivables, whereas cash accounting does not.

Difference between Cash Basis Accounting and Accrual Accounting

	Cash Basis Accounting	Accrual Accounting
Definition	According to this accounting principle, revenues and expenses are only acknowledged when there is a cash inflow or outflow.	It is the basis of accounting, according to which all revenue and expenses are recorded as soon as they become earned or incurred, regardless of when they are paid or received.
Nature	It is simple in nature.	It is complex in nature.
Accounting System Followed	The single entry method used by the cash basis of accounting records the inflow or outflow of cash.	It uses a double entry accounting system, meaning that every transaction has two possible outcomes: a credit and a debit.
Variations in Income System	Under the cash basis of accounting, the income statement will display a comparatively lesser income.	Higher income levels will be shown on the income statement under the accrual approach of accounting.
Accuracy	It has low accuracy.	It is more accurate than the cash basis of accounting.
Auditing of Financial Statement	A financial statement audit is not possible under the cash basis of accounting.	Only financial statements prepared using the accrual method of accounting are eligible for auditing.
Suitable For	It is suitable for micro to small businesses.	It is suitable for large corporations.

Example Of Cash and Accrual Accounting

Let’s examine an illustration of how accrual accounting and cash accounting have differing effects on the bottom line. Using a fictitious web design firm, we’ll look at a month’s worth of transactions.

Assume you perform the following business transactions over a month:

1. Send out a $5,000 invoice for a website design project that was finished this month.
2. Get billed $1,000 in developer costs for this month’s work.
3. For a bill you got last month, pay the fees of $75.
4. Receive $1,000 for a job that was invoiced last month from a client.

The profit for this month, calculated using the cash basis approach, would be $925 ($1,000 in income less $75 in fees).

The profit for this month, calculated using the accrual method, would be $4,000 ($5,000 in income less $1,000 in developer fees).

As you can see, the figures produced by the two approaches differ greatly.

How Cash vs Accrual Accounting Affects Your Taxes

The tax year in which your revenue and costs are recorded varies depending on the accounting system you use, which is one of the biggest distinctions between accrual and cash accounting.

Income is recorded as soon as it is received under cash-based accounting. Income is recorded as soon as it is earned when using the accrual approach.

As an example of how this impacts taxes, suppose that the transactions mentioned above happened in November and December of 2023. If you invoice a client for $5,000 in December 2023 using accrual accounting, even if you get payment in January 2024, you would still record that transaction as income for 2023 and have to pay taxes on it.

If you choose the cash basis, the transaction will be included in your 2024 taxable income, even though you will only record it once the payment is received.

Should a Small Business Use Cash or Accrual Accounting?

The IRS mandates that you utilize the accrual method if your company is a corporation (other than an S corporation) and your average gross revenues for the previous three years exceed $25 million. You are allowed to utilize the cash technique if your company doesn’t meet those requirements.

That being said, smaller companies without inventory typically find greater success with the cash technique. Your accountant would advise you to use the accrual approach if your company has a lot of inventory.

Important Note: In order to modify your accounting techniques, you must submit Form 3115 to the IRS for approval.

Accrual-basis and cash-basis accounting both have their advantages and drawbacks. There are rationalistic factors that can be used, including company size and budget availability, to explain why a particular business might select one system over the other. If, for some reason, you are unclear about which way is best for your business, consult a professional and figure out whether or not your company should utilize cash or accrual accounting.