Advantages and Disadvantages of Accrual vs Cash Based Methods
In bookkeeping, there are two commonly used methods: accrual and cash based. The method you choose depends on your business and level of income. Many small businesses have a choice of either the accrual or cash based method. If income is above $5 million, the accrual method must be used. Also, if a business’s inventory of items for sale to the public and gross receipts are over $1 million, the accrual method must be used. Inventory includes merchandise sold and supplies intended for sale.
With accrual and cash based bookkeeping, neither method provides a complete picture of the financial status of a business. While the accrual method provides an accurate depiction of the daily transactions of a business, it may be inaccurate in terms of cash reserves, hindering cash flow. For example, if there is a delay between making a sale and earning revenue from that sale, the income ledger will be inaccurate for that accounting period.
Utilizing the cash based method will provide a more accurate depiction of a company’s cash amount, but may be less accurate when depicting long-term profitability. For example, the cash method may reveal uneven months of profit as delayed revenue is collected.
Choosing either method will affect tax deductions at the end of the year. If expenses from one tax year are not paid until the next, those expenses cannot be claimed as deductions using the cash method. However, because transactions are recorded when they occur as opposed to when payment is received, deductions can be claimed using the accrual method.
With accrual and cash based bookkeeping, neither method provides a complete picture of the financial status of a business. While the accrual method provides an accurate depiction of the daily transactions of a business, it may be inaccurate in terms of cash reserves, hindering cash flow. For example, if there is a delay between making a sale and earning revenue from that sale, the income ledger will be inaccurate for that accounting period.
Utilizing the cash based method will provide a more accurate depiction of a company’s cash amount, but may be less accurate when depicting long-term profitability. For example, the cash method may reveal uneven months of profit as delayed revenue is collected.
Choosing either method will affect tax deductions at the end of the year. If expenses from one tax year are not paid until the next, those expenses cannot be claimed as deductions using the cash method. However, because transactions are recorded when they occur as opposed to when payment is received, deductions can be claimed using the accrual method.
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