In accrual basis accounting, revenues and expenses are recorded in the fiscal period in which they occur.
When you invoice someone for a product or service, you record the revenue and set up an account receivable for the same amount. Once the funds are received, the receivable is settled. Similarly, when you receive an invoice for a product or service you have purchased, you record the expense and set up an account payable for the same amount. When you pay that invoice, the payable is settled.
In cash basis accounting, revenues and expenses are recorded in the fiscal period in which the payment was received or made, regardless of when the revenue was earned or the expense was incurred. For example, if you invoice this month but collect the payment next month, the revenue will be recorded next month. In cash basis accounting, there are no accounts receivable or accounts payable.
Accrual and Cash Accounting: Advantages & Disadvantages
The major advantage of cash accounting is its simplicity. Transactions are only recorded once, generally when cash changes hands. Cash accounting also reduces bookkeeping and accounting fees.
Accrual accounting is based on the matching principle—recording revenues and the expenses used to generate those revenues in the same period. Accrual accounting, therefore:
- Paints a more accurate picture of true profitability, both overall or by specific job or project
- Provides the information required to predict and manage future cash inflows and outflows
- Allows management to more accurately analyze, budget, and forecast revenues, expenses, and profitability
Which Method of Accounting Should You Use?
There are many bookkeepers who fall back to cash accounting because it is, frankly, a lot easier to deal with than accrual accounting. However, accrual accounting is the method required by the CRA for tax reporting requirements for most corporations. Accrual accounting is also the method required under all financial reporting frameworks. For these reasons, Achen Henderson uses accrual accounting to manage our corporate clients’ finances.