Difference between Cash Vs. Accrual Accounting

What is the difference between Cash and Accrual Accounting?

Cash Vs accrual accounting are the two methods of accounting used by firms or organizations to maintain their books of accounts. And keep the books up to date for better management and smooth run of the business in the long term. Every business, for that matter, irrespective of its structure and size, needs to keep details of monetary transactions. Where these two methods are widely used for this purpose, before one decides on a preference or choice of the accounting method, one must understand the meaning and the difference between these two methods. Let us first discuss the meaning, and then we will detail the difference between Cash Vs Accrual accounting in the following paras.

Meaning of Cash vs. Accrual Accounting

Accrual Accounting

It is the accounting method where the activity or the transactions are recorded as and when they happen. The key is the event or the happening of the transactions. Transfer of money or money flow between the two transacting parties is not important. The same can happen in advance, at the same time, or after the transaction or the activity. The transaction is recorded immediately after it occurs. Thus in this method, the transactions are recorded when the amount becomes due or payable and whenever the money becomes receivable.

Cash Accounting

In cash basis method of accounting, the key concept is the exchange of money. Therefore, this method only records the transactions when there is a money flow or money transfer between the transacting parties. Thus, we can say that in this accounting method, the time of the event occurrence is of no importance. That means whether the activity or event had taken place in the past, present, or future is of no concern to the accounting staff. The movement of money is the only concern for the accounting staff.

Also read Accrual vs Deferral.

Example of Cash vs Accrual Accounting Methods

A Ltd., a supplier of clothes, sold goods of $5,00,00 to X Ltd. on 15th January. The transactions will be recorded in the following fashion under both these methods:

On Cash Basis:

If the sales transaction is happening in cash on 15th Jan, then:

Date Particulars Dr. Amount Cr. Amount
15th Jan Cash A/c                       500,000
To Sales 5,00,000
(For goods sold on a cash basis)

On Accrual basis

Let us assume the credit period to be 1 month for the transaction that happened on 15th Jan. In this case; there will be two separate entries passed on two different dates – the first one on the date of the transaction and the second one on the date when the money will be received after one month, as discussed below:

Date Particulars   Dr. Amount Cr. Amount
15th Jan X Ltd.  A/c                  500,000
To Sales A/c 500,000
(For goods sold on credit)
Date Particulars Dr. Amount Cr. Amount
15th Feb Cash A/c                      500,000
To X Ltd. 500,000
(For cash payment received)

Points of Difference in Cash vs. Accrual Accounting

As we now understand the meanings of these two accounting methods, let us now understand the key differences between the two methods. The key differences are:

Basis Accrual method Cash method

Key Factor: Revenue Recognition

Revenue Recognition happens as soon as the transaction is concluded. That means as soon as the service is rendered or the product is supplied.

Here, the transaction will be recorded only on receipt of the cash against the product or service supply. 

No. of Accounts Maintained

For every transaction, usually, the entries happen in three accounts :

  1. Account Receivables or Payables A/c

  2. Nominal A/c

  3. Cash A/c

However, in cash accounting usually, entries happen only in two accounts :

  1. Cash A/c

  2. Nominal A/c

Ease of Maintenance

This is a slight cumbersome task as it requires multiple accounts to be maintained.

This is an easier task as a lesser number of accounts are to be maintained

Suitability

This method is suitable for large organizations. Because they do transactions on credit also. And the movement of cash and the happening of transactions usually have different dates and volumes.  

This is suitable for small businesses as, normally, their day-to-day transactions are of a cash nature.

Accuracy

This method is considered more accurate as it covers the liability and income as they fall due, like payables and receivables. This is in line with the standard accounting principles. Because this way, it records all income and expenses during the accounting period itself. Thus this helps in reflecting the true and fair position of the business and performance for the period. 

This method is considered less accurate. Sometimes, it can mislead due to the long time span of the actual payment made or received. It makes it difficult to make a periodical comparison also. And does not give the true idea of the performance of the business.

GAAP

The GAAP approves this method

The GAAP does not approve this method

Taxation

This method is more appropriate for tax filing as it is believed to be more accurate in reality. And the taxation guidelines also work on similar lines.

This method does not convey the actual performance of the period and is less accurate. Hence, the taxation rules generally do not recognize this method of accounting. And for all the taxation purposes, the taxpayer has to make proforma, necessary adjustments to the profit and loss account, so arrived with this accounting method.

Trend Analysis

This is suitable if a company wants to know its trend analysis as it takes the events into account as soon as they occur.

This is not suitable for the trend analysis as the transactions are recorded after the payment is received or made. It might be possible that the payment is made before or after the occurrence of the event, so this will not give a fair view.

Conclusion

Since both the methods have their own benefits and drawbacks, it is difficult to say which is best among the two methods. More so, it depends upon the size of the business and the nature of the business too. So the preference or choice has to be made in line with the business requirements. The difficulty or ease for the purpose of taxation also remains an important consideration to avoid a lot of duplication.

Continue reading Fundamentals of Accounting for more details.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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