I always thought that accounting was based on cash - payments and receipts. Recently I heard about the concept of accrual accounting. Can somebody please explain what the difference is between accrual and cash accounting?When do we use cash accounting and when do we use accrual accounting?
Cash Accounting and Accrual Accounting are two different methods of creating financial records.
Cash Accounting is a very simple method of accouting whereby transactions are recorded when cash passes hand i.e. when a customer pays for their goods or services or where expenses are physically paid by the business. The business's success is therefore a measure of the bank balance.
The main advantage is that it is a very quick and easy method of accounting and is therefore appealing to small business owners. The downside is that it does not take into account any sales and purchases on credit. If the business sells good to customers on credit or purchases from suppliers on credit, this method is not the most appropriate as these transactions will be disregarded until they have been settled i.e. the cash has been transfered.
Cash Accounting bears no regard to matching revenues and expenses with the period to which they relate, and it bears no regard to matching revenues with the expenses incurred in creating those revenues.
Accrual Accounting is a more complex accounting process, however it produces a much more accurate image of the state and success of the business's operations. Revenues and expenses are recorded in the correct period, regardless of when they are paid. Accounts receivable and accounts payable can be tracked so that the business owner can, at a glance, determine how much cash is still to come in and how much will be required to be paid in the short and long term. And revenues are matched against the expenses incurred in creating those revenues e.g. sales are matched with cost of sales.
Cash Accounting should only be used by a business that operates solely in cash with no sales or purchases on credit. All other businesses should use the Accrual Accounting method.
Some accounts that will appear in Accrual Accounting but not Cash Accounting financials are: