Difference Between Cash Accounting and Accrual Accounting
Cash accounting is where income and expenses are realized when they are paid or received, whereas accrual accounting is where you realize the income once you provide the service and realize the expense once you have taken the service.
There are two kinds of accounting
- Cash accounting, the business will only record the transaction when cash inflow or outflow occurs.
- Accrual accounting, on the other hand, income and expenses are recorded whenever they occur.
So, you can see that there is a huge difference between these accountings.
As an example, we can say that cash flow analysis is done by following cash accounting and income statement is created by following accrual accounting. But according to the companies’ act, only accrual accounting is recognized.
In this article, we will look at each accounting in detail and then we will go through a comparative analysis between them.
Cash vs Accrual Accounting Infographics
Key Difference Between Cash and Accrual Accounting
You may ask why most businesses don’t use cash accounting and only use accrual accounting. Very recently, Biocepts transitioned from Cash Accounting to accrual accounting as they believed it is a more timely reflection of revenues associated with test volumes as well as revenues and expenses.
Let us now look at some important differences –
- Size of business: It matters a lot what size of business you own. If you own a business that is micro-sized and you earn a small amount of cash flow from it (that means you happen to deal with the minimum amount of transactions), then cash accounting is the best method to use. But if you have a small, medium, or large business; then it’s wiser to go with an accrual accounting basis.
- Simplicity: Accrual basis of accounting has the capacity to deal with complex types of transactions. But cash accounting only handles simple transactions. That’s why at the beginning of any business, business owners prefer to go with cash accounting.
- Tax advantage: If you own a micro-business, it’s better to go for the cash accounting method; because by using the cash accounting method, you would be able to get the tax advantage. But for a larger business, tax advantage can only be tapped by using the accrual method of accounting.
- Time of transaction: On the accrual basis of accounting, the time of the transaction is very important. As per the accrual method of accounting, the accountant records the transaction when it occurs (not when the money would be received). But the cash accounting method is the complete opposite. In the cash accounting method, the transaction is recorded when the cash is received or expended. In this case, the accrual basis of accounting has a demerit. The disadvantage is the firm needs to pay taxes even when the company is yet to receive the revenue (a great example of this is sales on credit).
- Double-entry Systems – Cash accounting follows a single entry system. Accrual accounting follows a double-entry system.
- Accuracy – Cash accounting isn’t very accurate as the focus is only on cash. Accrual accounting is comparatively more accurate.
- Holistic – Cash accounting isn’t a holistic method of accounting. But accrual accounting is a holistic method of accounting.
|Basis for Comparison||Cash Accounting||Accrual Accounting|
|1. Meaning||In cash accounting, incomes and expenses are only recognized through cash.||In accrual accounting, incomes and expenses are recognized when they are done (on the mercantile basis).|
|2. Includes||Only cash expenses, cash incomes.||All expenses and all incomes.|
|3. Nature||Simple and easy to understand.||Complex and difficult to understand.|
|4. Recognized by||Not recognized by Companies Act.||Recognized by Companies Act.|
|5. How accounting is done?||When cash is received or paid.||When revenue is earned or loss is incurred.|
|7. Why useful?||We can quickly get how much cash the business generated (i.e. net cash flow).||We can understand how much profit or loss a business has made during a particular period.|
|8. Holistic in approach||No, because it only talks about cash.||Yes, because it includes all of the transactions.|
|9. Which one is more accurate?||Accuracy of cash accounting is doubtful since it doesn’t take every transaction into accounting.||It is a more accurate method of accounting.|
Both are important in their respective areas. A sole-proprietorship company that has just been starting its business should follow cash accounting since it’s easy to maintain and there are only a few financial transactions in the beginning. On the other hand, in the case of a large-cap company, accrual accounting is best because cash accounting wouldn’t be able to handle hundreds and thousands of financial transactions per day.
That means you need to understand which company accounting is applicable. Sure accrual accounting is always a more evolved method of accounting, but without employee support, it’s almost impossible to maintain.
Video on Cash Accounting vs Accrual Accounting
This has been a guide to cash vs accrual accounting. Here we discuss the top differences between cash and accrual accounting with infographics and comparison table. You may also have a look at these articles below for further learnings in accounting –
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