Cash Basis vs. Accrual Basis Accounting

A question that many entrepreneurs do not know the answer to is, “what method of accounting are you using?”.

Before being able to answer this question, it is important to understand what an accounting method is and which ones exist. In this post, we explain this.

First, what is an accounting method?

An accounting method simply describes the approach (or basis) used when recording transactions in your accounting software.

There are three methods, described below: Cash Basis, Accrual Basis and Tax Basis.

Cash basis: Cash basis accounting records transactions only when cash is spent or received. For example, if someone paid you for a project in December that you didn’t perform until January, the revenue would be shown in December under cash basis accounting.

Accrual basis: This is the method required by US generally accepted accounting principals (GAAP). In this method, revenue is recognized when earned and expenses are recognized as incurred, even if cash has not yet been received or paid. In the example above, the revenue would not be recognized until January, when the work is performed. This method of accounting creates things like accounts payable and accounts receivable, prepaid assets and deferred revenue. These items then get cleared when the cash changed hands.

Tax basis: tax basis accounting is essentially cash basis accounting and additional changes in things such as depreciation to conform with certain tax rules.

So which one should you use?

Most businesses decide to use accrual basis accounting given that it provides the most accurate depiction of business operations and the fact that it is not much different than cash basis.

The main difference between cash and accrual basis is that you will enter in invoices and bills into the accounting system as revenue/expenses are earned/incurred - something you will likely want to do anyways from a tracking perspective.

Do I need to maintain a separate set of tax books?

In most cases, absolutely not. Your tax accountant will be able to easily convert your books from accrual to tax basis when filing your tax return.

To summarize, accrual basis accounting is the most accurate and in most cases, will eventually be required as your business scales. Maintaining accrual basis accounting is not much more complex than cash basis - it essentially just requires you to invoice your customers when revenue is earned and create bills in your accounting system as the business incurs expenses. Your tax accountant will then make any necessary adjustments in your tax returns in order to present in tax basis.

Accruity