A look at the difference between accrual and cash accounting methods
Updated: Nov 8, 2024
A look at the difference between accrual and cash accounting methods
Writer: Klinsmann Lee
What is accrual and cash accounting:
The accrual accounting method recognises revenue and expense in the period they occur, but not when cash is received or paid.
The cash accounting method recognises revenue when cash is received and expense when cash is paid.
The difference between accrual and cash accounting methods is when the transaction occurs. [1]
The advantages and disadvantages of the accrual accounting method:
The accrual accounting method is the standard accounting practice for many companies given the following advantages:
Accuracy: It looks at the underlying business transactions including both current and expected transactions (accruals). As such, it provides a better picture of the financial health and performance of the company.
Follow the matching accounting principle: The principle states that expense should be recorded in the same period to which the corresponding revenue is earned. Accrual accounting is prepared based on this matching accounting principle and therefore provides a clearer relationship to the cause and effect between income and expense.
Better financial analysis: Accrual accounting methods track revenues not yet received payments and expenses not yet made payments (example: deferred revenue, accrued revenue, prepaid expenses, accrued expenses) – these are not represented in financial statements under cash accounting. An accurate picture of the financial health of the company is important because it helps analysts and the management team make better financial decisions on improving financial performance. [2]
There are always two sides to a coin – The disadvantages of the accrual accounting method include: [3]
More complex: Under cash accounting methods, transactions are recorded based on when cash is received and paid. With the accrual accounting method, there are rules and procedures to follow so that certain types of income and expenses are recorded consistently and in the correct period.
Managing Liquidity: The accrual accounting method does not provide an accurate picture of cash flow – The income statement can show revenue of thousands of dollars. However, it does not mean that the company has received the cash until the client settles the invoices. Understanding cash flow is important for the company to manage liquidity risk.
Fraud Risk: With the accrual accounting method, it is important to implement a good system of control to prevent employees from conducting internal fraud. There is more reliability with cash accounting as transactions are recorded when cash is received and paid.
Conclusion:
The main difference between accrual and cash accounting methods is the timing recognition of the transactions.
The accrual accounting method is the standard accounting practice in preparing income statements and balance sheets.
Other Information:
Reference: Please see the “references” section to acknowledge the sources used in this article. For any mistakes made in this article, feel free and let me know.
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