Cash Versus Accrual Accounting

Accrual accounting maintains a complete General Ledger, including accounts for receivables, payables, inventory, and payroll taxes. You have used accrual accounting for all of the businesses you have seen so far.

Businesses that operate on a cash basis (with very limited credit purchases or sales) and have immediate turnover of inventory can produce reasonably accurate financial statements using cash accounting. In this chapter, you will see how cash accounting simplifies the bookkeeping for Sonja's Art and Frame Shop. You will also learn to convert books from cash to accrual accounting using period-end adjusting entries. Although the result will be less accurate than straight accrual accounting, it will be accurate enough for most purposes.

One of the first decisions a business and bookkeeper must make is which method of bookkeeping to use, cash or accrual. If the business wants to use cash accounting, the bookkeeper will need to consider carefully the volume of receivables, payables, payroll, and inventory, and be qualified to make conversion entries to accrual accounting when necessary.

Accrual accounting is generally preferred (and often required) because it includes greater detail. However, it also requires more time and effort to maintain.

Cash accounting is designed for those who require a simple bookkeeping system recording money received and money paid out. You don't record expenses, purchases and sales until the cash is received or disbursed.

Therefore, under the cash method of accounting, you don't make entries for accounts receivable, accounts payable, or inventory. The sale of merchandise to customers on credit is recorded as a sale on the day the money is received (not on the day the sale was made). Expenses or the cost of items purchased for resale are recorded on the day you pay for them, not on the day you received them.

Cash accounting works well for service based companies where the company expects cash payment when the job is complete such as some medical offices. However, where inventory is involved, complications often times arise since sales made on the basis of a 30-day future payment are not recorded until you receive the money even though the customer received the inventory at the time of the sale.

Advancing Your Account-Ability, Module III of the Professional Bookkeeper Program, explains Cash Versus Accrual Accounting in detail.

Click HERE to see what else is taught in Module III.