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.

Types of Accounting

The two methods of tracking your accounting records are:

• Cash Based Accounting
• Accrual Method of Accounting

Cash Based Accounting

Most of us use the cash method to keep track of our personal financial activities. The cash method recognizes revenue when payment is received, and recognizes expenses when cash is paid out. For example, your personal checkbook record is based on the cash method. Expenses are recorded when cash is paid out and revenue is recorded when cash or check deposits are received.

Accrual Accounting

The accrual method of accounting requires that revenue be recognized and assigned to the accounting period in which it is earned. Similarly, expenses must be recognized and assigned to the accounting period in which they are incurred.

A Company tracks the summary of the accounting activity in time intervals called Accounting periods. These periods are usually a month long. It is also common for a company to create an annual statement of records. This annual period is also called a Fiscal or an Accounting Year.
The accrual method relies on the principle of matching revenues and expenses. This principle says that the expenses for a period, which are the costs of doing business to earn income, should be compared to the revenues for the period, which are the income earned as the result of those expenses. In other words, the expenses for the period should accurately match up with the costs of producing revenue for the period.

In general, there are two types of adjustments that need to be made at the end of the accounting period. The first type of adjustment arises when more expense or revenue has been recorded than was actually incurred or earned during the accounting period. An example of this might be the pre-payment of a 2-year insurance premium, say, for $2000. The actual insurance expense for the year would be only $1000. Therefore, an adjusting entry at the end of the accounting period is necessary to show the correct amount of insurance expense for that period.

Similarly, there may be revenue that was received but not actually earned during the accounting period. For example, the business may have been paid for services that will not actually be provided or earned until the next year. In this case, an adjusting entry at the end of the accounting period is made to defer, that is, to postpone, the recognition of revenue to the period it is actually earned.

Although many companies use the accrual method of accounting, some small businesses prefer the cash basis. The accrual method generates tax obligations before the cash has been collected. This benefits the Government because the IRS gets its tax money sooner.