cash basis and accrual basis

8/3/2019 Cash Basis and Accrual Basis

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CASH BASIS ACCOUNTING ACCRUAL BASIS ACCOUNTING

1. “Cash-Basis” accounting means you only count revenue and expenses that you actually

have.Things that count: Receiving a check or creditcard payment, writing a check to the telephonecompany, paying your credit card bill.Things that don’t count: Receiving a purchaseorder, receiving the bill from the telephonecompany, charging something on a credit card.So it counts only if real, hard cash comes in orgoes out. Stuff that hits a bank account.

“Accrual-Basis” accounting means youcount pledged revenue and expenses. It’s the

opposite of cash-basis — what counts arepurchase orders (customers pledging to pay you), bills arriving (vendors you’re pledgingto pay), and credit card purchases (debt you’re incurring). It doesn’t matter when youpay the bill or when the customer actually sends you a cheque.

2. With cash-basis accounting, you show a profitonly if you have excess cash actually in your

possession. If it’s in the bank, you can set itaside for taxes. It’s like a dagger through theheart, but you can afford it.

Not so with accrual-basis. If you get a hugepurchase order from a new customer that

would show as income; then the IRS wantstheir 30%, but since the customer hasn’tpaid, you don’t have the cash to pay.

3. Revenue only counts when the cash is in thebank (cash-basis)

Expenses count immediately (accrual-basis)

4. The original value of an asset for taxpurposes (usually the purchase price),adjusted for stock splits, dividends and

return of capital distributions. This valueis used to determine the capital gain,which is equal to the difference betweenthe asset's cost basis and the currentmarket value. Also known as "tax basis".

An accounting method that measuresthe performance and position of acompany by recognizing economic events

regardless of when cash transactionsoccur. The general idea is that economicevents are recognized by matchingrevenues to expenses (the matchingprinciple) at the time in which thetransaction occurs rather than whenpayment is made (or received). Thismethod allows the currentcash inflows/outflows to be combinedwith future expected cashinflows/outflows to give a more accurate

picture of a company's current financialcondition.

5. Cash basis tax payers include income when itis received , and claim deductions whenexpenses are paid.

Accrual basis taxpayers include items whenthey are earned and claim deductions whenexpenses are incurred .



6. Smaller companies that haven't formally incorporated and most sole proprietors usecash-basis accounting because the system iseasier for them to use on their own, meaningthey don't have to hire a large accounting staff.

All incorporated companies must useaccrual accounting according to thegenerally accepted accounting principles(GAAP). If you're reading a corporation'sfinancial reports, what you see is based onaccrual accounting.

7. Expenses and revenues aren't carefully matched on a month-to-month basis.Expenses aren't recognized until the money isactually paid out, even if the expenses areincurred in previous months, and revenuesearned in previous months aren't recognizeduntil the cash is actually received. However,cash-basis accounting excels in tracking theactual cash available.

Expenses and revenue are matched,providing a company with a better idea of how much it's spending to operate eachmonth and how much profit its making.Expenses are recorded (or accrued) in themonth incurred, even if the cash isn't paidout until the next month. Revenues arerecorded in the month the project iscompleted or the product is shipped, even if the company hasn't yet received the cashfrom the customer.

8. In cash accounting, the company doesn'trecord the liability until it actually pays thegovernment the cash. Although the company incurs tax expenses each month, the company using cash accounting shows a higher profitduring two months every quarter and possibly even shows a loss in the third month when thetaxes are paid.

In accrual accounting, each month acompany sets aside the amount it expects topay toward its quarterly tax bills foremployee taxes using an accrual (papertransaction in which no money changeshands, which is called an accrual). The entry goes into a tax liability account

9. Cash basis accounting is a simple andinexpensive method to implement and utilize.It also provides an accurate representation of cash flow. Additionally, the cash basis methodprovides the opportunity to "defer taxableincome by delaying billing so that payment isnot received in the current year.

One disadvantage of accrual basisaccounting is that it is more complicatedand expensive to implement and employ than the cash basis method.Another disadvantage to using the accrualbasis method is that the company may owetaxes on revenue before payment is actually received.

10. Many small businesses that do not have tokeep track of inventory use the cash method.Under the cash method, you do not record your income until cash (or check) is actually received from your customer or affiliate andexpenses are not recorded until you actually pay for them.

Accrual basis accounting is more widely used among “bigger” small businessesespecially those with inventory and thosewho extend credit to their customers.

11. Since the cash basis technique does notrecognize receivables or payables, it is not anaccurate method of measuring profit.

However, accrual basis accounting "providesa more accurate picture of how a business isperforming over the long-term than the cashmethod"



12. For example, you own a heating and airbusiness and you repaired a heating system inDecember, but didn’t actually receive any money from your customer till sometime in January that sale would not be recorded onthat year’s books even though you finished the

job in December. It would be recorded in thenext year’s books when you actually received acheck from that customer.

For example, your business finishes aservice job in December, and doesn’t getpaid until February of the next year, underthe accrual basis accounting method youwould record the sales amount in December,a more accurate picture of your financial

situation. Since you don’t have the money yet, the amount would be recorded asaccount receivable.

13. All financial transactions events are based on

cash basis. This applies to all incoming

receipts or outgoing payments or outflows of an

enterprise.

Unlike the cash basis accounting method,

accrual method is based on the matching

and prudence concept. It also considers the

proper way of recognizing revenue.

14. Based on this accounting method, revenue of

the enterprise is not been properly taken up

nor expenses in relation to earning the revenue

are accounted for. In other words, we can say

that Cash-basis accounting does not recognize

promises to pay or expectations to receive

money or service in the future, such as

payables, receivables, and prepaid expenses.

Without this accrual accounting method,

the entity is not able to reflect the true

obligations to its suppliers or the correct

amount owing by its customers.

15. Normally, cash basis accounting applies to

very small concern where the recordings of

transaction are simple and does not need toconfirm to any generally acceptable accounting

principles. Also, cash basis accounting applies

when the accounting process is very short for

example, the supplier invoices needs to be paid

very early or billings and collections involves a

very short span of time.

Normally, accrual accounting is practiced

during the accounting close so as to take up

all expenses and revenue not yet taken inthe books of accounts. This normally form

part of the accounting routine of the

accounting month end adjustments.

16. No provisions should be made for bad debts. Either set up a bad debt reserve fund or

establish criteria for writing off uncollectible

debts.

17. Unpaid bills aren't part of the accounting

system.

Unpaid bills are expensed, whether or not

you've physically paid for the goods in

question.



18. When you purchase fixtures or equipment, you

pay cash and expense the item then and there.

You'll expense purchases of major assets

over their useful lives, often on a five-year

schedule.

19. Like unpaid bills, unpaid compensation

doesn't figure into the accounting equation.

At the end of each accounting period,

accrued (but unpaid) salaries, benefits andleave allowances are "booked."

20. Cost basis can produce a "statement of

receipts and disbursements.

Accrual basis can produce full-fledged

profit-and-loss statements and balance

sheets.

21. Cost basis recognize income when it's received. Accrual basis recognize income when it's

earned, whether you receive the cash or not.

22. Intangible assets have no beating on a cash

basis system.

If your name or a product line develops anintrinsic reputation, you may be able to

book goodwill as an estimate of the fiscal

value of the assets.

23. In cash basis the value of work in progress is

ignored.

In accrual basis it will record work in

progress as an asset at the end of

accounting periods.

24. When you buy, you book the items purchased

as expense.

You'll book inventory as an asset and only

charge inventory items to expense when

they're actually used.

25. Pay a bill in advance and you treat it as a

simple expense.

Advance payments are "held" as liabilities on

the balance sheet. When you receive the

goods or services you paid for, the "real"

expense is recorded.

26. If a customer pays you in advance or furnishes

a deposit, you treat the proceeds as a current

receipt

You'll treat advance payments as prepaid

revenue and record them as "real" revenue

when you actually furnish the goods or

services to the customer.

cash basis and accrual basis

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