In accounting, cash and accrual accounting are two critical parts.
The difference between these two is the timing of when the sales and purchases have been recorded in the accounts.
- Cash accounting records revenue and expenses when they are received or paid in cash. In contrast, accrual accounting records income and expenses when earned or incurred, regardless of when money is received or paid.
- Cash accounting is more straightforward than accrual accounting but may need to represent a company’s financial performance and cash flow accurately.
- Accrual accounting is more complex and requires more detailed record-keeping, but it provides a more accurate and comprehensive view of a company’s financial position and performance.
Cash Accounting vs Accrual Accounting
Cash accounting is a simpler method suitable for small businesses. Accrual accounting is more complex and better suited for larger companies with more complex financial transactions, providing a more accurate picture of a company’s financial health since it takes into account all transactions.
So, to give you a brief, cash accounting is a recording of payments that have been received, while accrual accounting is a recording of payments when they are incurred, and it doesn’t matter when cash has been exchanged.
|Parameter of Comparison||Cash Accounting||Accrual Accounting|
|Transaction||Records only cash transaction||Records both cash and credit transaction|
|Standard||Doesn’t follow international accounting standards||Follows international accounting standard|
|Uses||Rarely used||Widely used|
|Cash Flow||Ensures only the company’s total cash flows||Ensures the company’s both accrual and cash flow|
|Limitation||No representation of the company’s overall financial changes||Representation of a company’s overall financial changes.|
What is Cash Accounting?
When it receives cash, a company recognizes it as revenue and the money paid as expenses; when these two transactions get recorded, they are termed cash accounting.
Under this method, there is no recognition of accounts payable or receivable. Cash accounting is often opted for by small companies because it is easier to maintain. Cash accounting allows the record keeper to check all the transactions quickly.
The bank statement has all the details of money coming in and going out; no one needs to keep track of money received and paid. Also, cash accounting enables a company to track down how much cash the organization has at any given point.
All you have to do is look at the bank statement, and you will understand how many resources are left at your disposal.
Also, because the organization will not record the transaction unless the cash leaves or goes in, the business doesn’t get taxed either, unless there is no cash transaction.
What is Accrual Accounting?
Accrual accounting is very different from cash accounting. In this term, every revenue and expense gets recorded, and it doesn’t matter when the money gets paid or received by a company.
Let us explain to make you understand accrual accounting better.
Let’s say you are done with a project, so the project’s revenue will be calculated when you complete the project, and it doesn’t matter whether you have been paid for it or not.
This method is used more often. More and more businesses do accrual accounting because it gives you a more realistic picture of the expenses and income during a specific period.
This way, you get to have a long-term view. The only problem with accrual accounting is that it doesn’t give you a clear picture of the cash flow of your business.
Your business might seem to be earning a lot of profit, whereas, in reality, your bank account might be empty.
Main Differences Between Cash Accounting and Accrual Accounting
- In cash accounting, incomes and expenses are recorded only when a cash transaction occurs. However, in accrual accounting, cost and income are recorded when they are done.
- Cash accounting includes only cash income or expense, whereas each type of income expenditure will be recorded in accrual accounting.
- Because of its nature, cash accounting is straightforward, whereas accrual accounting is complicated and challenging to understand.
- The Companies Act does not recognize cash accounting but accrual accounting.
- If your business is micro-sized and your company earns just a tiny amount of cash flow, then you might want to consider cash accounting because it is easy to use. However, accrual accounting is better for those with big, medium, or small-scale businesses.
- Accrual accounting can deal with different types and complex transactions, but cash flow can only deal with simple transactions.
- In cash accounting, you will follow a single-entry system only, whereas, in accrual accounting, you will follow a double-entry system.
- Accrual accounting follows a holistic approach, but cash accounting is not considered a comprehensive accounting method.
- Cash accounting is designed to deal with simple day-to-day transactions, while accrual is meant for a more complex type of transaction.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.