Cash Method Versus Accrual Method

Cash Method versus Accrual Method

Cash method

Use of cash method in the process of determining taxable income requires the businesses to record their income once the cash has been received and to record expenses upon paying for them.

Accrual method

This method is the exact opposite of cash method. Accrual accounting revenues are recorded when the sales are made or services offered, while expenses are recorded upon receipt of goods or services.

Factors determining the choice of the choice of the accounting method

Selling stocks inventory to the public; where the company or other the business holds stocks to be sold to the public, International Reporting Standards (IRS) recommends that such organizations should use the accrual method, hence excluding the use of the cash method.

First income tax filing; once the organization has reported its first taxable income using a particular accounting method, such as accrual method or cash method, changing from one of the methods to the other requires approval by the IRS.

IRS requires all organizations and companies making annual sales of over $5million per annum to use the accrual accounting method, in the process of calculating their taxable income.

Accounting methods Usage example

ABC Company sold 50 bags of cement to XYZ Company worthy $300 on credit terms, to be repaid on 31st Dec 2017. In this case, using the accrual accounting method, ABC Company will record the sales/ revenue of $300 in their income statement when the supply of the cement is made. Under cash method, the revenue will not be recorded till 31st Dec 2017. On the other hand, using the accrual accounting method, XYZ Company will record the expense of $300 in their income statement upon receipt of the 50 bags of cement. Under cash accounting method, the expense will be captured in the income statement on 31st Dec 2017 that is upon making payment for the supplied cement.

Accrual accounting method and cash accounting methods can be used interchangeably by organizations, but the factors determining their usage must be factored out. Financial statements prepared under the accrual accounting method can report high figures at year end as opposed to cash method. This is based on the fact that some transactions have been recorded and the settlement has not been made. Cash flow statement made under accrual method can be misleading at some times.

References

Cash Basis vs. Accrual Basis Accounting, retrieved from; https://www.accurants.com/blog/cash-basis-vs-accrual-basis-accounting/

Deciding between Cash-Basis and Accrual Accounting, retrieved from; http://www.dummies.com/business/accounting/deciding-between-cash-basis-and-accrual-accounting/