There are two primary bases of accounting – cash basis of accounting and accrual basis of accounting. The differences arise due to income and expenses being recorded at different times under the two methods. Here are the most common differences between the two methods.
Cash Basis of Accounting
The cash basis is the ‘simpler’ method of the two primary bases of accounting. This method records income at the point in time when an organization receives the income. Likewise, expenses are recorded at the point in time that they are paid. Even though this method is more simple than accrual accounting, this method does not conform to Generally Accepted Accounting Principles (GAAP).
The accrual basis of accounting shows how much an entity has earned (regardless if money is received) and spent (regardless if paid) during a period. Unlike the cash method of accounting, there are typically ‘receivable’ and ‘payable’ accounts that are shown on the financials. Common examples include the following accounts – accounts receivable (an asset account) and accounts payable (a liability account). Additionally, this method does conform with Generally Accepted Accounting Principles (GAAP), as accrual basis more accurately shows an entity’s financial picture at year-end and can more easily be compared to the financial statements of other entities.
Per IRS guidance, the cash basis may not be used if an entity brings in more than $5 million of income in a year. As a result, the accrual basis of accounting is used by most entities, and especially by larger ones.
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