Cash basis and accrual accounting are two confusing terms, and sometimes people use them interchangeably, which is not correct. In his article, “Cash basis accounting vs. accrual accounting,” McCool (2020) highlights the salient differences between these two accounting methods. The article opens by distinguishing these two, using both text and a summary table of the dissimilarities, and then discusses how each accounting alternative affects taxes and cash flow. At the end of the article, the author gives advice and recommends a better option for small businesses.
The first distinction between these two accounting methods is based on when a company records sales and purchases. In cash accounting, revenues and expenses are recognized after the money has changed hands, while in accrual accounting, expenses are recognized when billed and revenues after they have been earned (McCool, 2020). Therefore, the former does not recognize payable or receivable accounts as the latter does. The second difference is that cash basis accounting does not accumulate tax on revenues that have not been received, unlike the accrual method, which accrues taxes on debts. Therefore, these two accounting options are different, dictating whether small or big businesses can use either of them.
The appropriateness of either accounting method for use depends on the business’s net worth. Small companies, which average below $25 million and sole proprietors without an inventory, should use cash accounting because of how it affects cash flow and axes (McCool, 2020). On the other hand, the accrual method is best suited for corporations, averaging over $25 million for three consecutive years in gross receipts (McCool, 2020). The reason is that this accounting option recognizes revenue once it is earned and expenses when they are billed since most big companies are inventory-heavy.
Reference
McCool, C. (2020). Cash basis accounting vs. accrual accounting. Bench. Web.