In regards to bookkeeping, businesses have a choice between two accounting methods: Cash or Accrual. Under Generally Accepted Accounting Principles (GAAP), the accrual basis should be used. Essentially, in a nutshell, this is the difference between these two accounting methods:
- Under the cash basis, revenues and expenses are reported on the income statement based on the date cash is received from customers, and for expenses, the date cash is paid out.
- In contrast, the accrual basis reports revenues when they are earned, and expenses when they are incurred (but not necessarily paid).
Businesses are required to use the accrual basis when they have sales of more than $5 million per year, or if they stock inventory for resale to the public and gross receipts are more than $1 million. The accrual method also shows the ebb and flow of business income and debts more accurately on financial statements. Here is additional information on the differences between these two methods.
- Receivables are reported as assets under the accrual basis, but not the cash basis.
- Revenues are reported when they are earned (accrual basis), or when they are received (cash basis).
- Payables are reported as liabilities with the accrual basis, but not reported with the cash basis.
- Expenses are reported when they are incurred (accrual basis), or when they are paid (cash basis).
- The balance sheet is more complete with the accrual basis, because under the cash basis some assets and liabilities are not included. Equity also changes depending on whether you’re using the accrual or cash basis.
The accrual method has a distinct tax advantage if expenses incurred (but not paid) in 2016 (for example) can be deducted on your 2016 taxes. And income received but not earned (a customer payment in 2016 for goods to be delivered in 2017) can be reported on your 2017 return.
For guidance, contact a professional bookkeeper or CPA.