What is Cash Accounting, Explanation & Examples? - CruseBurke

 Cash accounting is a method of accounting in which payment receipts are recorded during the period in which they are received, and expenses are recorded during the period in which they are actually paid for. Cash accounting is also known as accrual accounting. To phrase it another way, revenues and expenses are only tallied when cash is actually exchanged for goods or services.

Cash accounting is also known as cash-basis accounting, and it can be contrasted with accrual accounting, which recognises income at the time that the revenue is earned and records expenses at the time that liabilities are incurred regardless of when cash is actually received or paid. Cash accounting also refers to the practise of keeping financial records based on cash transactions.

Understanding Cash Accounting

One of the two types of accounting is known as cash accounting. The second method is known as accrual accounting, and it involves recording income and expenses as soon as they are incurred. Cash accounting is typically used by smaller businesses because it is not only easier and more straight-forward, but it also paints a more accurate picture of the amount of money that is actually available to the company. However, in accordance with Generally Accepted Accounting Principles (GAAP), corporations are required to use an accounting method known as accrual accounting (GAAP).

When transactions are recorded using a cash basis, the effects of those transactions on a company's books do not occur immediately after the transaction has been completed. As a direct consequence of this, cash accounting is typically not as accurate as accrual accounting in the short term.

The cash method of accounting is the one that is used by the vast majority of small businesses, but the accrual method is the one that is mandated by the Internal Revenue Service for companies that have annual gross receipts of more than 25 million.

In addition, the Tax Reform Act of 1986 makes it illegal for C corporations, tax shelters, certain types of trusts, and partnerships that have C Corporation partners to use the cash accounting method to report their financial transactions

Take note that businesses are required to report their tax information using the same method of accounting that they use for their own internal bookkeeping purposes.

Cash Accounting: A Real-World Example

Suppose that, in accordance with the cash accounting method, Company A realises a profit of 10,000 from the sale of 10 computers to Company B on November 2, and records this transaction as having taken place on that date. The fact that Company B actually placed the order for the computers on October 5 is disregarded as irrelevant because the company did not pay for them until November 2, when they were physically delivered.

Accrual accounting, on the other hand, would have required Company A to record the sale of 10,000 on October 5 despite the fact that no cash had been exchanged at that point in time.

In a similar fashion, cash accounting requires businesses to record their expenses after they have actually paid for them, rather than when the expenses were incurred. In the case where Company C hires Company D for pest control on January 15, but does not pay the invoice for the service completed until February 15, cash accounting dictates that the expense will not be recognised until February 15. However, if accrual accounting was used, the expense would have been recorded in the books on January 15—the date it was first incurred—rather than later.

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