Accrual and Cash Accounting Essay
Accrual and Cash Accounting
Cash account and accrual accounting are two separate methods that are similar in many aspects except when it comes to debits and credits. Cash accounting is also known to be called cash basis accounting. This approach allows for the recognition of income at the time it is received. That means that invoiced income is not counted as an asset until payment for the invoice has been received and vice versa for debits and expenses. Accrual accounting does not recognize any income until it is actually earned. Goods and services are posted and counted as assets as they are invoiced.
Cash basis accounting is simple and cheaper to do than accrual accounting. While it does provide an accurate representation of cash flow, it does not comply with the revenue recognition principle or the matching principle. The revenue recognition principles requires revenue to be recognized when it is earned not received. The matching principle requires expenses to be matched against the related revenues, not when the cash is paid. It is not an accurate measure for profit since it does not recognize receivables or payables.
You could show your company earning a profit when in fact the company is losing money. The IRS generally requires all businesses to use the accrual basis of accounting on their tax returns. Only when certain specific criteria is met does the IRS allow the use of cash basis accounting. If a company meets that criteria then it would be beneficial to go that route since cash accounting usually defers income taxes.