Cash Accounting

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DEFINITION

An accounting method where receipts are recorded during the period they are received, and expenses are recorded in the period in which they are actually paid. Cash accounting is one of the two forms of accounting. The other is accrual accounting, where revenue and expenses are recorded when they are incurred. Small businesses often use cash accounting because it is simpler and more straightforward, and it provides a clear picture of how much money the business actually has on hand. Corporations, however, are required to use accrual accounting under generally accepted accounting principles.

Also called cash-basis accounting.

INVESTOPEDIA EXPLAINS

Under a cash accounting system, if Company A receives $10,000 for the sale of 10 computers from Company B on Nov. 2, the accountant records the sale as having occurred on Nov. 2. The fact that Company B placed the order for the computers on Oct. 5 is irrelevant, because it did not pay for them until they were delivered on Nov. 2. Under accrual accounting, by contrast, the accountant would have recorded Company A as having received the $10,000 on Oct. 5, even though no cash had changed hands yet.

Likewise, under cash accounting, companies record expenses when they actually pay them, not when they incur them. If Company C hires Company D for pest control on Jan. 15 but doesn’t pay the invoice until Feb. 15, the expense would not be recognized until Feb. 15 under cash accounting. Under accrual accounting, however, the expense would be recorded in the books on Jan. 15.

A drawback of cash accounting is that it may not provide an accurate picture of liabilities that have been incurred but not yet paid for, so the business might appear to be better off than it really is. At the same time, cash accounting means that a business that has just completed a large job for which it is awaiting payment may appear to be less successful than it really is, because it has expended the materials and labor for the job but not yet reaped the rewards.


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