Question

Cash Basis vs. Accrual Basis Accounting

Differentiate between cash-basis accounting and accrual-basis accounting. Why is accrual-basis accounting the preferred method for most businesses? The Internal Revenue Service requires all companies with sales over $5,000,000 to use the accrual-basis of accounting for income tax reporting purposes. Why?

Answer 1

Differences between cash system and accrual system of accounting are described as follows:-

1. Under cash system of accounting revenue and expenses are recognized when amount is actually paid or received in cash

2. Compliance with generally accepted accounting principle is must in accrual system of accounting whereas no such compliance is required under cash system

3. Revenues and expenses are recorded under accrual system when services are rendered and amount is actually earned no matter whether cash is received or not. The same way expenses are reported in the period when they occur and not when amount is paid in cash.

4. Accrual system provides a better picture of company’s profits as transactions are recorded when they are earned but under cash system completion of transaction is not necessary and therefore recording on the basis of cash received or paid is not correct

5. Cash method is simple and easy to use whereas accrual method is comparatively complex

6. Cash basis of accounting is best suitable for small businessman who lack much knowledge of accounting as maintaining and recording financial information is bit easier

The Internal Revenue Service requires all companies with sales over $5,000,000 to use the accrual-basis of accounting for income tax reporting purposes due to following reasons;

1 It becomes easy to match income and expenses in the current year.
2 It will help the companies in reflecting the current financial position of an organization more accurately and takes away any potential misrepresentation of financial information in reporting.
3 It also eliminates the possibility of under or overstating revenues and expenses.