The primary difference between the two principal business accounting methods for financial reporting purposes, cash basis accounting and accrual basis accounting, is the point in time when revenue and expenses are recorded.
When using the cash basis method, revenue is recorded when payment is received from customers and expenses are recorded when payment is made to vendors and employees. Cash basis accounting is simple and straightforward and provides a clear picture of the actual amount of money the company has on hand. However, the random timing of revenues and expenses can create extremes in reported revenue, expenses and profits. This method is the simplest and is widely used by small business, but may not properly reflect the complete results from operations.
When using the accrual basis method, revenue is recorded when it is earned and expenses are recorded when consumed. The revenue is recorded even if cash has not been received and expenses are recorded even if the expense has not been paid. The accrual method is essentially a matching of revenues to expenses; therefore, producing a complete picture of business performance. Accrual accounting is the most common method used by businesses for financial reporting, monitoring and measuring performance.
Choosing the appropriate accounting method for your financial reporting is an important decision that will direct everything from how you record transactions to financial reporting. Understanding the differences in the methods will allow you and your Accountant to choose the right method for your business.
