This article will help you understand two methods of accounting in detail and also discern how they differ from one another. Along with the underlying principles that govern them, the article will also help you understand which accounting method is best suited for your business.
CASH ACCOUNTING
As the name suggests, this method has more to do with the exchange of cash between different parties. Moreover, it involves acknowledging revenue or expense at the time that a sale or purchase occurs. This is a comparatively more straightforward approach, and since it has a definitive time frame of when transactions take place, they can be recorded more effectively.
Further, since you are dealing with real-time cash flows, it is also easy for you to understand the exact amount of capital that is available with the business at any point in time. Lastly, since you will not be recording incomes until you procure the cash, you will not be taxed for that period.
ACCRUAL ACCOUNTING
Though cash accounting may seem like the obvious approach, you may be surprised to hear that most organizations (especially the large ones) prefer this approach. The term 'accrue' means to accumulate or receive over a period. Accrual accounting is the process of acknowledging revenue and expense at the time of the transaction, irrespective of when the exchange of cash takes place.
For example, if you sell a table with the promise of receiving the payment for it a month later, you will still add the payment to your revenue at the time of sale. This is how this method majorly separates itself from the traditional cash accounting technique.
Now, there are critics of this approach, as it might add unnecessary complexity to the books of the business. However, accrual accounting gives a more realistic picture of the financials of a business since it considers the long-term value created. Additionally, given that a considerable portion of a business's dealings is done in credit, it helps simplify those transactions.
A potential challenge that comes with this method is the ignorance of cash flow. This may lead to the business falsely displaying large profits while, in fact, they have run dry. As a result, if a business does not carefully monitor its cash flow while employing accrual accounting, there may, unfortunately, be catastrophic consequences.
THE BEST METHOD FOR YOUR BUSINESS
If your business is registered as a corporation with more than $25 million in annual revenue, the IRS requires you to use the accrual technique. If that is not the case, then you are free to choose whichever method you feel is better for your business. Most accountants and financial advisors do suggest the accrual method regardless, for reasons mentioned above. However, for a non-inventory-based boutique business, the cash method works just fine.
Also, let us know which technique you use for your business and why you think it's better.
From India, Gurgaon
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CASH ACCOUNTING
As the name suggests, this method has more to do with the exchange of cash between different parties. Moreover, it involves acknowledging revenue or expense at the time that a sale or purchase occurs. This is a comparatively more straightforward approach, and since it has a definitive time frame of when transactions take place, they can be recorded more effectively.
Further, since you are dealing with real-time cash flows, it is also easy for you to understand the exact amount of capital that is available with the business at any point in time. Lastly, since you will not be recording incomes until you procure the cash, you will not be taxed for that period.
ACCRUAL ACCOUNTING
Though cash accounting may seem like the obvious approach, you may be surprised to hear that most organizations (especially the large ones) prefer this approach. The term 'accrue' means to accumulate or receive over a period. Accrual accounting is the process of acknowledging revenue and expense at the time of the transaction, irrespective of when the exchange of cash takes place.
For example, if you sell a table with the promise of receiving the payment for it a month later, you will still add the payment to your revenue at the time of sale. This is how this method majorly separates itself from the traditional cash accounting technique.
Now, there are critics of this approach, as it might add unnecessary complexity to the books of the business. However, accrual accounting gives a more realistic picture of the financials of a business since it considers the long-term value created. Additionally, given that a considerable portion of a business's dealings is done in credit, it helps simplify those transactions.
A potential challenge that comes with this method is the ignorance of cash flow. This may lead to the business falsely displaying large profits while, in fact, they have run dry. As a result, if a business does not carefully monitor its cash flow while employing accrual accounting, there may, unfortunately, be catastrophic consequences.
THE BEST METHOD FOR YOUR BUSINESS
If your business is registered as a corporation with more than $25 million in annual revenue, the IRS requires you to use the accrual technique. If that is not the case, then you are free to choose whichever method you feel is better for your business. Most accountants and financial advisors do suggest the accrual method regardless, for reasons mentioned above. However, for a non-inventory-based boutique business, the cash method works just fine.
Also, let us know which technique you use for your business and why you think it's better.
From India, Gurgaon
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Dear member,
The Cash Accounting approach is a very old technique that was used in traditional small-scale businesses. Moreover, this is not compliant from an IT Act point of view and with the latest accounting standards.
Nowadays, the accounting system has become dynamic, requiring a lot of expertise and a detailed breakup of every cost and expense. Hence, even a petty businessman is doing accounting on an accrual basis only.
The criteria of $25 million are not clear. Now, even a 1 million businessman is also filing IT Returns, which is not possible through the Cash Accounting System. Only the Accrual Accounting system can provide relevant and real-time situational analysis. Therefore, I would recommend adopting only Accrual Accounting.
From India, Delhi
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231The Cash Accounting approach is a very old technique that was used in traditional small-scale businesses. Moreover, this is not compliant from an IT Act point of view and with the latest accounting standards.
Nowadays, the accounting system has become dynamic, requiring a lot of expertise and a detailed breakup of every cost and expense. Hence, even a petty businessman is doing accounting on an accrual basis only.
The criteria of $25 million are not clear. Now, even a 1 million businessman is also filing IT Returns, which is not possible through the Cash Accounting System. Only the Accrual Accounting system can provide relevant and real-time situational analysis. Therefore, I would recommend adopting only Accrual Accounting.
From India, Delhi
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