In the field of accounting, both cash accounting and accrual accounting are two important forms. Students enrolled in the field of accounting must have knowledge about these two forms of accounting. Both terms play an important role for a company. For example – cash accounting is used to record the cash transactions whereas accrual accounting helps in analysing the position of a business. Students must know the difference between the two terms of accounting.
Cash Accounting of Cash Basis Accounting
Cash accounting is explained as an accounting method where payment receipts are recorded in the receipt column whereas expenses are recorded in the paid column. Cash accounting is also known as cash-basis accounting. It does not notice accounting payable and accounts receivable. It is easy to maintain thus many small businesses use cash basis accounting. It takes place when a transaction takes place where your bank is affected. It also helps you to track the cash of the business. You do not need to pay taxes for your business’s income until the cash is paid or received.
Accrual accounting is used to measure the position and performance of an organisation by knowing economic events regardless of when transactions have occurred in cash. Here, only expenses and revenues are recorded which are earned regardless of money is paid or received. Where the upside of accrual accounting is, it provides a realistic idea of expenses and income of a business at a certain period whereas downside is it does not give details of cash flow.
In such a situation, business seems to be in profit but in reality, it has empty bank accounts.
What are the effects of accrual and cash basis accounting?
One should have the understanding and difference between the two forms of accounting i.e. cash and accrual accounting. We already have discussed the meaning of cash and accrual accounting. These both accounting terms have their individual effects.
For example –
Let us assume the monthly transactions of a business are:
- Sent an invoice for $6,000 for project
- Received a bill for $2,000 from a company
- Paid $125 in regards to a bill
- Received $800 from a partner in regards to a project
Now, we will discuss the effect on cash flow. It will be like –
- As per the cash basis accounting method, the profit for this month would be $1975 (subtracting $125 fee from $2,000 of income)
- By using the second form of accounting that is the accrual method, the profit for the given month would be $4,000 (It can be identified by subtracting $2000 from $6,000 income).
- The above example shows the ways in which income stream and cash flow are affected by the accounting processes.
The Effect on Taxes
Now, we assume that the above example lies in November & December of 2018. Let us see that which tax year expenses and income the accrual and cash accounting are going to affect.
Using cash basis accounting, income or expenses are recorded when a business receives it, whereas, in the accrual method, income and expenses are recorded when a business earns it.
By using accrual accounting for the above example, if an invoice for $6,000 is for December 2018, the transaction would be a part of the 2018 income and you should pay taxes on it, even if you end up receiving the payment in January of 2019.
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