In accounting, cash and accrual accounting both are two critical parts.
The difference between these two is the timing when the sales and purchases have been recorded in the accounts.
Cash Accounting vs Accrual Accounting
The main difference between cash accounting and accrual accounting is that cash accounting happens when you receive or else pay money, and accrual accounting occurs when you raise a bill or an invoice. Although accrual accounting is critical, cash accounting has its own benefits.
So, to give you a brief, cash accounting is a recording of payments that have been received, while accrual accounting is recording of payment when they are incurred, and it doesn’t matter when cash has been exchanged.
Comparison Table Between Cash Accounting and Accrual Accounting (in Tabular Form)
| Parameter of Comparison | Cash Accounting | Accrual Accounting |
|---|---|---|
| Transaction | Records only cash transaction | Records both cash and credit transaction |
| Standard | Doesn’t follow international accounting standard | 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?
A company when it receives cash recognizes it as revenue, and the money paid as expenses, and when these two transactions get recorded, they are termed as cash accounting.
Under this method, there is no recognition of accounts payable or receivable. Cash accounting is often opted by companies that are small in size 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, and no one needs to keep track of money receiving and paying. Also, cash accounting enables a company to track down how much cash the organization has at any given point.
All you got to do is take a look at the bank statement, and you will understand how much 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 transaction of cash.
What is Accrual Accounting?
Accrual accounting is very different from cash accounting. In this term, every revenue and expense gets recorded, and it didn’t matter when the money got paid or received by a company.
Let us give an explanation to make you understand accrual accounting better.
Let’s say you are done with a project, so the revenue of the project 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. The reason why more and more businesses do accrual accounting is that it gives you a more realistic picture of the expenses and income during a certain period of time.
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 completely empty.
Main Differences Between Cash Accounting and Accrual Accounting
- In cash accounting, incomes, as well as expenses, are recorded only when there is a cash transaction. However, in accrual accounting, cost and income are being recorded when they are done.
- Cash accounting includes only cash income or expense, whereas, in accrual accounting, each type of expenditure of income will be recorded.
- Cash accounting because of its nature is straightforward to understand, whereas accrual accounting is quite complicated and challenging to understand.
- The Companies Act does not recognize cash accounting; however, accrual accounting is.
- If your business is micro-sized in size and your company earns just a small amount of cash flow, then you might want to consider cash accounting because it is easy to use. However, those who have big, medium, or small-scale business, accrual accounting is a better option for them.
- Accrual accounting can deal with different types of and complex types of transactions, but cash flow can deal with simple transactions only.
- In cash accounting, you will be following a single-entry system only, whereas, in accrual accounting, you will be following a double-entry system.
- Accrual accounting follows a holistic approach, but cash accounting is not considered to be a comprehensive method of accounting.
- Cash accounting is designed to deal with simple day-to-day transactions, while accrual is meant for a more complex type of transaction.
Conclusion
It must be clear by now that both cash and accrual accounting is essential.
The only thing that genuinely differentiates these two is the time of recording these transactions.
One is easier to follow, while the other is better for complex transactions.
If
there is a company that has just started, cash accounting would be the best
option; however, when it comes to big, medium, or small who want a more
holistic accounting approach, accrual accounting is a better option.
The
reason why prominent and established companies prefer accrual accounting is
that it is not easy for these companies to take care of hundreds of daily
transactions.
Before
applying accrual or cash accounting, you first need to understand the nature of
your business.
References
- https://www.elibrary.imf.org/view/IMF005/10411-9781462371730/10411-9781462371730/10411-9781462371730_A001.xml?language=en
- https://www.ceeol.com/search/article-detail?id=174051
- https://www.inderscienceonline.com/doi/abs/10.1504/IJAAPE.2012.047807