Counting on Accounting: Cash Vs Accrual Accounting

Every business is unique in its way and so are its methods of working. Depending upon the need of the business or the ease of owner they decide the way they wish to transact with customers, products, purchase, sales, and stakeholders or even with the books of account. Where there are two types of recording transactions, viz. Cash accounting and accrual accounting; businessman opts for the one that suits his objectives.

What is cash accounting?

In simple terms, recording the transaction when the cash is paid is cash accounting. Be it income or expenditure, when the cash is transacted, is the time when the transaction is recorded in the book of accounts. For example, if the x party has purchased something from y in January and has not paid any cash for the transaction done in the same month. The transaction will not be recorded. On the other hand, when the party clears the due in February, the transaction is recorded in February.

Is that suitable for your business type?

Since this is real-time cash transaction tapping, it is always the first choice, so that the cash gets tallied. But in actuality, this is more suitable for all those who deal with a limited cash business transaction. Moreover, if the business is small and mostly the type of transaction done is cash-based, this should suit your business needs.

Accrual Accounting

In simple terms, this is the type of account where the transactions are recorded even when they are not realized in cash. This is exactly the opposite of recording the cash transaction. The income or expenditure is recorded in the book of accounts irrespective of the time frame when it has occurred. For instance, when Vendor A sells his good to B and asks him to settle his accounts to clear his dues in the weekend, B has an increase in purchasing power and hence this leverages his business. A would only record the transaction without the time or cash constraint as he is dealing with books by the accrual accounting method.

Keeping the stuff simple, cash being earned or not, the revenue is recorded as soon as the product is sold or the services are offered, ensuring that the expenditure is recorded as well.

Is that suitable for your business type?

Well, if you are dealing with huge cash transactions, or you are in macro business; it is a sure shot Yes! When you have more than certain cash transactions, it is not manageable to record them always. Hence the same is recorded in the accrual accounting pattern.

Let’s get into a sneak peek as to how cash accounting differs from accrual accounting.

If you wish to know your exact cash transaction done in a day, cash accounting shall be a great aid. Think of a moment when you recorded cash but have not paid in the expenses, will that give you the exact picture? The answer to the same is NO!. The income in cash can be recorded if done in the day whereas in accrual the expenditure and income both can be recorded, hence providing you the exact picture. Cash accounting will not provide you with a clear picture if payable and receivable are not done on the same day.

Cash is the easiest way to apply in day-to-day accounting methods, whereas accrual is a bit complex. However, GAAP and IFRS acknowledge the accrual accounting method.

The income level recorded in the cash accounting system will be less and the levels in comparison will be more in the accrual accounting system as the cash will be actual and the income will be assumed.

Cash received can be part of actual cash on hand in the cash accounting system, whereas Income is not equal to cash flow.?All in all,?Different business has different strategies and so is the accounting system. Pick up the method that suits the need of the business.

Written by CA Karan Ranka