Accrual and cash accounting are two different methods of recording financial transactions. Accrual generates accurate historical records, while cash accounting is easier to use and requires fewer monthly inputs. Companies with $5 million USD in annual sales must switch to accrual accounting.
The accrual basis and the cash basis are two different types of accounting methods. Although a company can choose any of the methods to record financial transactions, larger companies often use the accrual basis. The biggest difference between the accrual basis and the cash basis is the transaction record. The accrual basis requires companies to record transactions as they occur; The cash base records transactions when cash changes hands during a transaction. Minor differences occur outside of this significant requirement.
Companies that use accrual basis accounting often experience better historical reporting. Occurrence-based transaction recording means that each accounting period accurately reflects each month’s business. Owners and managers can review these reports and determine what sales and cash flows to expect in the future. Between the accrual basis and cash accounting, only accrual generates accurate historical records. Historical cash base reports indicate in which months the business experienced high cash receipts or cash payments.
Another difference between the accrual and cash methods of accounting is the statement of cash flows. The accrual basis cannot track cash flows accurately. As transactions occur, cash changing hands is not a requirement. Therefore, a company can experience high sales and low cash flow. The statement of cash flows identifies the major sources and uses of cash for businesses that use accrual accounting.
Cash accounting does not require a separate statement of cash flows, although a business can still prepare one if it wishes. A company experiences accurate cash accounts in the general ledger because the general ledger reflects the bank account. This correspondence between the two allows a business to ensure that it has enough cash on hand to run its operations. However, the statement of cash flows helps to identify the sources of cash.
Each accounting method is acceptable for reporting financial information. For small businesses deciding between the accrual and cash accounting methods, they often choose the latter. The cash basis is easier to use and requires fewer monthly inputs. Business owners who are unfamiliar with major accounting principles can use the cash basis until their businesses grow to a certain size. At this point, companies are usually better off using accrual accounting.
There are no specific rules in national accounting standards for switching between accrual basis and cash accounting. However, accountants use general guidelines. Companies with $5 million US dollars (USD) in annual sales must switch to accrual basis accounting. The change in accounting methods also applies to companies with $1 million in inventory-based sales.
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