Major Differences Detween Cash and Accrual Accounting

Major Differences Detween Cash and Accrual Accounting

The difference between cash and accrual accounting stems from the fact that most business transactions

involve two events and, moreover, these events can occur at different times. The seller delivers goods or services (one event) and the buyer pays for the goods and services (another event). These events may occur more or less simultaneously or there may be a time lapse between them. Either event may precede the other.

The seller may deliver goods, for instance, then invoice the customer and wait 30 days or more for payment. Or the seller may receive payment "up front," and then deliver later (e.g., when the buyer leases floor space, the payment is typically made before the occupancy period).

• Under cash basis accounting, the seller's paid expenses for delivering goods or services are recorded only when they actually occur. Similarly, the seller records cash received from the customer only when that occurs, even if time passes between the events, and even if they occur in different accounting periods.

The generally accepted accounting principles (GAAP) in most countries, however, incorporate the matching concept, the idea that reported incoming revenues should be matched (reported in the same accounting period) with the costs that bring them. Otherwise, reported margins and profits are misleading.

• In contrast to cash basis accounting, the alternative—accrual accounting with adouble entry system—achieves matching by using two pairs of transactions for a single sale. For the seller, closing the sale and delivering goods or services brings two bookkeeping entries (a debit to one account and a credit to another), while receiving the customer's cash payment brings another two entries (again, a debit to one account and a credit to another). Similarly, the buyer records two transactions when the payment is owed, and  another two when cash is paid. Under accrual accounting, the reported income for both buyer and seller is based on each party's first pair of transactions—i.e. entries showing the money earned (for the seller) and the money owed (for the buyer).