Cash Basis Accounting vs. Accrual Basis Accounting

ACC/290
January 28, 2013
Paulette Schirmer

Cash Basis Accounting vs. Accrual Basis Accounting
When a business opens its doors it needs to decide which accounting method to use to keep their financial records. The two accounting methods are the cash basis and the accrual basis. Both methods can be used, but the company should choose which method would be a good fit for their company. Cash basis accounting method is strictly cash in, cash out basis. This means that financial transactions are recorded only when money is given or paid (Kimmel, Weygant, & Kieso, 2009). Cash basis is used mostly by small business where owners want a simple way of understanding their financial statement just to see if there is a profit or loss in the company. The income and expense is more accurate (“Cash Basis”, 2004-2013).
In the accrual basis accounting method income is reported in the period it is earned, regardless of when it is received, and expenses are recorded when they have incurred even if it were paid (Kimmel, Weygant, & Kieso, 2009). According to Entrepreneur Media, Inc. (2013), the accrual method requires a business’s annual sales be over $5million and its venture be structured as a corporation. Also businesses with inventory is to use the accrual basis as well, and it is highly recommended to use the accrual basis if the business sells or pays on credit.
Cash basis will always see income when the money is received. Accrual basis will see the income in their books even if they receive the money was not received. An example of this is say a company sold $2,000 of baking pans on January 29, but was not paid for them until February second after they were delivered. Under the cash basis, the transaction will be recorded on February second, but the accrual basis will record the transaction on January 29.
What happens when a little company has grown and was using the cash basis method and wants to change to the accrual basis method. That company will need to get permission from the United States Internal Revenue Service (IRS) in advance before changing their method of accounting. If permission is not asked in advance, the results could be penalties imposed by the IRS (Wolfe, 2013).

References

Cash Basis. (2004-2013). Retrieved from http://www.investorglossary.com
Entrepreneur Media, Inc. (2013). Accrual Accounting. Retrieved from http://www.entreprenuer.com
Kimmel, P.D., Weygandt, J.J., & Kieso, D.E. (2009). Financial Accounting Tools For Business Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc..
Wolfe, L. (2013). How Can I Change Accounting Methods. Retrieved from http://www.womeninbusiness.about.com/od/federaltaxfags/f/change-accounting methods.htlm