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Accrual basis and cash basis are two different types of accounting methods. While a business can choose either method to record financial transactions, larger companies usually use accrual basis. The biggest difference between accrual basis and cash basis is the recording of transactions. Accrual basis requires companies to record transactions as they occur; cash basis records transactions whenever cash changes hands during a transaction. Minor differences occur outside of this significant requirement.
Companies that use accrual basis accounting often experience better historical reporting. Recording transactions based on occurrence means that each accounting period accurately reflects business for each month. Owners and managers can review these reports and determine what sales and cash flows to expect in the future. Between accrual basis and cash basis accounting, only accrual results in accurate historical records. Historical cash basis reports indicate which months the company experienced high cash receipts or cash payments.
Another difference between accrual basis and cash basis accounting methods is the statement of cash flows. Accrual basis is unable to track cash flows accurately. As transactions occur, cash changing hands is not a requirement. Therefore, a company can experience high sales and low cash flow. The statement of cash flows identifies the major sources and uses of cash for companies using accrual accounting.
Cash basis accounting does not require a separate statement of cash flows, although a company can still prepare one if desired. A company experiences accurate cash accounts in the general ledger because the ledger mirrors the bank account. This matching between the two allows a company to ensure they have enough cash on hand to run their operations. The statement of cash flows helps to identify sources of cash, however.
Each accounting method is acceptable for reporting financial information. For small businesses deciding between accrual basis and cash basis accounting methods, they often choose the latter. Cash basis is easier to use and requires fewer entries on a monthly basis. Business owners unfamiliar with major accounting principles can use cash basis until their businesses grow to a certain size. At this point, businesses are often better off using accrual accounting.
No specific rules exist in national accounting standards for switching between accrual basis and cash basis accounting. Accountants do use general guidelines, however. Companies with $5 million US Dollars (USD) in annual sales should switch to accrual basis accounting. The switch in accounting methods also applies to companies with $1 million USD in inventory-based sales.