A:

The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method is mostly used by small businesses and for personal finances. The cash method accounts for revenue only when the money is received and for expenses only when the money is paid out. On the other hand, the accrual method accounts for revenue when it is earned and expenses goods and services when they are incurred. The revenue is recorded even if cash has not been received or if expenses have been incurred but no cash has been paid. Accrual accounting is the most common method used by businesses.

For example: Let's say you own a business that sells machinery. If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check. Under the accrual method, the $5000 is recorded as revenue immediately when the sale is made, even if you receive the money a few days or weeks later. The same thing occurs for expenses. If you get an electric bill for $1700, under the cash method, the amount is not added to the books until you actually pay the bill. However, under the accrual method, the $1700 is recorded as an expense the day you get the bill.

Learn more about Financial Statements in our article, What You Need to Know About Financial Statements.

RELATED FAQS
  1. What is the difference between accrual accounting and cash accounting?

    Understand the differences between the two basic methods of accounting commonly used by businesses: cash accounting and accrual ... Read Answer >>
  2. When are expenses and revenues counted in accrual accounting?

    Take an in-depth look at the treatment of revenues and expenses within the accrual method of accounting and learn why many ... Read Answer >>
  3. When are businesses required to use accrual accounting?

    Determine when the accrual accounting method must be used instead of cash accounting. Most businesses use accrual accounting ... Read Answer >>
  4. What is accrual accounting used for in finance?

    Read about the accrual method of accounting, its uses and rules, and why it is considered so important for investors, lenders ... Read Answer >>
  5. When is accrual accounting more useful than cash accounting?

    Learn when accrual accounting is more useful than cash accounting when trying to determine a company's performance over a ... Read Answer >>
  6. Why does GAAP require accrual basis rather than cash accounting?

    Discover why GAAP requires the accrual basis for accounting rather than the cash basis, and learn why it is important for ... Read Answer >>
Related Articles
  1. Investing

    Operating Cash Flow: Better Than Net Income?

    Differences between accrual accounting and cash flows show why net income is easier to manipulate.
  2. Investing

    Don't Lose Your Shirt On Mutual Fund Sales

    Mutual funds aren't guaranteed profit-makers, but with the right calculations and timing, you can avoid major losses.
  3. Personal Finance

    Alternate Methods Of Online Payment

    Paying by credit is one of the most common methods of payment for online shopping in the U.S. However, there are many other options worth testing out.
  4. Investing

    The Importance Of Analyzing Accounts Receivable

    While investors often focus on revenues, net income, and earnings per share, they should not overlook the importance of analyzing accounts receivable.
  5. Investing

    The Essentials Of Corporate Cash Flow

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself.
RELATED TERMS
  1. Modified Cash Basis

    An accounting method that combines elements of the two major ...
  2. Modified Accrual Accounting

    An accounting method commonly used by government agencies that ...
  3. Accounting Method

    The method by which income and expenses are reported for taxation ...
  4. Transaction

    1. An agreement between a buyer and a seller to exchange goods, ...
  5. Direct Method

    The direct method is a method of creating the cash flow statement ...
  6. Constant Yield Method

    One of two ways of calculating the accrued discount of bonds ...
Hot Definitions
  1. Trustee

    A person or firm that holds or administers property or assets for the benefit of a third party. A trustee may be appointed ...
  2. Gross Domestic Product - GDP

    GDP is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  3. Debt/Equity Ratio

    The D/E ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity.
  4. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
  5. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  6. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
Trading Center