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Wednesday, October 13, 2010

The Cash versus Accrual Accounting

Accounts Receivable is an asset that is owed to you but you do not have money in the bank or property to show you own something -it is intangible, on paper. It grows or accumulates as you issue invoices; therefore, Accounts Receivable is part of an accrual accounting system.

Double-entry accounting is the most accurate and best way to keep your financial records. With a computer, you don’t have to fully understand all the accounting details. Basically, in double entry accounting each transaction affects two or more categories or accounts, so everything stays in balance. Therefore, if you change an asset balance by issuing an invoice some other category balance changes as well. In this case, when you issue an invoice, the category that balances the asset called Accounts Receivable is an income or a sales account.

When you bill your client, there is an increase in income (on paper) and hence an increase in Accounts Receivable. When you are paid, the paper asset turns into money you put in the bank – a tangible asset. Through a process of recording the payment and the deposit, Accounts Receivable decreases and the bank balance increases. This accounting program takes care of all the accounting details.

This paper income can be confusing if you don’t understand that it is the total of all invoiced work, both paid and unpaid. If you have invoiced clients for a total of $10,000 but only $2,000 has been paid, your income will be $10,000 and your Accounts Receivable balance will be $8,000, and your bank account has increased by the $2,000 you received. An accountant would call this an accrual accounting method.

A cash accounting method only counts income when money is received, and it does not keep track of Accounts Receivable.

However, in real life, small businesses tend to use both methods without realizing the difference until income tax time.

This program can handle both accrual and cash based accounting. You can use the G/L Setup option in the G/L module to select either Cash or Accrual based accounting. We recommended that you consult with your accountant to determine which system will work best for you.

1 comment:

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