A business can record revenue (earnings) and expenses in one of two ways. The cash and accrual bases of recordkeeping define revenue and expenses in different ways.
The
CASH basis of accounting
records revenue and expense as the business owner pays for them. The Net Income (difference between revenue and expenses) of the company is determined by
subtracting CASH OUT from CASH IN.
The
ACCRUAL basis of accounting
attempts to place earnings and expenses in the same month, based on the matching principle. Cash is NOT necessarily the same as Revenue. Under the accrual system, Revenue is recorded WHEN EARNED.
On the IRS form (Schedule C), one of the first questions asked of the sole proprietor (single owner) is which accounting method the company will use. The methods are cash, accrual, or other. The "other" method can be a combination of the 2 systems. The cash method can be used for expenses and revenue. The Accrual method can be used for inventory.
THE CASH BASIS OF RECORDING EARNINGS
A majority of small businesses use the cash method of accounting. It is simple to understand. Record the earnings of the business ONLY when the CASH is received. ALL Expenses are recorded when the Check or Cash is Issued. ***
Payments are considered made when they are mailed.*** Under the Cash method, Credit Card Charges are considered PAID when you sign them, NOT when you pay the bill. You may use a combination of the cash method and accrual method if this combination clearly shows your income and expense transactions and is used consistently. A business owner cannot switch between cash, accrual, or combination accounting.
THE ACCURAL BASIS OF RECORDING EARNINGS
Accrual accounting is a more difficult system to understand because it involves the timing of revenue and expenses. This timing may have nothing to do with the payments or receiving of cash. Revenue is recorded when it has been earned, and expenses are recorded when they are incurred, whether they are paid or not paid. Accrual basis accounting should be used in all cases in which the production, purchase, and sale of merchandise is a factor in revenue. This would include inventories. The major differences between cash and accrual methods of recording revenue and expenses
