What are the primary differences between cash basis accounting and accrual accounting?
The main differences are in the way both methods or accounting recognize income and expenses.
With the cash basis method we recognize and record income when we receive it from the customer. Likewise, we recognize an expense when that expense is actually paid with cash, check or credit card.
Like everything else in life there are exceptions to this rule. Actually both the cash and accrual methods of accounting are rarely ever 100% cash or accrual, both methods of accounting contain elements of each other. This makes it necessary to understand both methods of accounting because in reality they are hybrids of one another.
The cash basis method is the easiest to understand when you are first starting because you don’t have to include elements of time that are included in the accrual method.
The cash basis method and the accrual method are used differently by different types of businesses. If you are keeping your company books for tax purposes then the cash basis method is the easiest and most efficient to use.
Smaller businesses like landscape contractors and remodeling contractors of all types, restaurants, shop owners, on-line businesses, gas stations, convenient stores, lawyers, IT businesses, repair shops and many more receive their income and pay their expenses in the same month so they would be prime candidates for using the cash basis method of accounting.
Larger businesses that have to carry receivables and payables and want to keep books for management purposes would normally use the more complicated accrual method of accounting.
The cash basis method is most suited to those types of businesses that want the easiest method of bookkeeping available. It is the system that about 75% of small businesses use because they also file their year-end tax returns on the cash basis method. It is approved by the IRS for both of these purposes.
If you have fallen behind in your bookkeeping like so many small business owners do then you would only use the cash basis method to catch up. You would not use the accrual method to catch up unless that is the same way you are filing your tax returns. If you wait until the end of the year to take your information to an accountant, to do the work for you, they would use the cash basis method in order to catch up the work and make it ready for tax filing.