Guide to Cash or Accrual Accounting

How to decide which accounting method best fits your needs
By Kay Bell

Cash-based accounting recognizes income when the money is received. Accrual-based accounting recognizes income when goods are shipped or services rendered. For expenses, under the cash method, an expense is recognized when you pay it. Under the accrual method, the cost is recognized when your company is obligated to pay it.

For accounting purposes, most businesses opt for the accrual method. Cash-based accounting can distort the true operations of your business and incorrectly reflect income. The choice generally is yours, although in certain circumstances the IRS requires companies to use the accrual method. And some businesses decide to use a hybrid of the two.

In determining which accounting system to use for your business, you should:

1.                           Understand the requirements of each method

2.                           Examine accounting software

3.                           Consider hiring a professional bookkeeper

Action Steps

The best contacts and resources to help you get it done

Accounting 101 Basically, the two accounting methods differ only in the timing of when transactions are credited or debited. In practice, though, accounting is rarely basic.

I recommend:  You can find good primers on the accounting methods at Nolo.com, Business Owner"s Toolkit, Inc.com and American Express. You can print out a PDF version of this guide to cash vs. accrual accounting provided by Texas A&M University to read at your leisure.

Computerize the process Unless you"re running a micro-business, you probably have your accounts on computer. But does your current software meet your accounting needs? And will it allow you to change as your business grows?

I recommend:  Top Ten Reviews looks at the pluses and minuses of, you guessed it, ten business accounting programs. The Logos accounting program also provides a side-by-side look at some factors to consider in deciding whether to use the cash or accrual method.

Hand over the books Regardless of whether you choose the accrual or cash accounting method, you"ll probably find that hiring an accountant to keep track of the numbers is a worthwhile expense.

I recommend:  Gaebler Ventures and is4profit each offer tips on how to hire a business accountant. The first recommendation is to ask for local referrals. But you also can find business accountants via the practitioner search engines at Accountants World, GoodAccountants and the National Society of Accountants.

Tips & Tactics

Helpful advice for making the most of this Guide

·                 Make sure you understand the financial and tax implications of the accounting method you choose.

·                 When considering a computer accounting solution, look for one that supports your entire company — sales, service, accounting — so that you can integrate all your financial applications.

·                 Make sure the accountant you choose is a business accountant. The needs of individuals are much different than those of a business.

·                 In that same vein, look for an accountant who knows the needs of your particular industry.

United Kingdom

According to Accountancy Age"s 2005 league table, fee income amongst the Top 50 accounting firms in the UK rose from £6.3bn to £7.0bn. This followed two successive years in which fee income had declined, largely a result of the sale by some of the larger firms of their consultancy arms. As detailed in the next section, fee income in most business areas - audit, tax, corporate finance and consultancy - rose in the 2005 survey, with insolvency and wealth management being the only segments where revenue fell.

PricewaterhouseCoopers remains the largest firm with fee income totalling £1,780m followed by Deloitte (£1,350m), KPMG (£1,066m) and Ernst & Young (£945m). The combined revenue of the Big Four accounted for £5.0bn, 72% of the fee income of the Top 50, down from 78-79% in the years up to the 2002 survey and the third year in succession a decline in their share has occurred (Chart 1). Ernst & Young"s fee income is the smallest of the largest four firms, but still over three times that of the next largest firm, Grant Thornton. The amount of fee income tapers off amongst the mid-tier firms so that in total there were only 25 firms that each generated more than £15m of revenue in the 2005 survey ^[14]

For more details regarding British qualified accountancy professionals, refer to the page of British qualified accountants

Double Entry Accounting

Financial accounting is based on double-entry bookkeeping procedures in which each transaction is recorded in opposite columns of the accounts affected by the exchange. Double entry accounting is a significant improvement over simple and more error-prone single-entry bookkeeping systems.

Fundamental Accounting Model

The balance sheet is based on the following fundamental accounting equation :

Assets  =  Liabilities  +  Equity

This model has been used since the 18th century. It essentially states that a business owes all of its assets to either creditors or owners, where the assets of a business are its resources, and the creditors and owners are the sources of those resources.

Transactions

To record transactions, one must:

1.Identify an event that affects the entity financially.

2.Measure the event in monetary terms.

3.Determine which accounts the transaction affects.

4.Determine whether the transaction increases or decreases the balances in those accounts.

5.Record the transaction in the ledgers.

Most larger business accounting systems utilize the double entry method. Under double entry, instead of recording a transaction in only a single account, the transaction is recorded in two accounts.

The Accounting Process

Once a business transaction occurs, a sequence of activities begins to identify and analyze the transaction, make the journal entries, etc. Because this process repeats over transactions and accounting periods, it is referred to as the accounting cycle.

Introduction

The purpose of accounting is to provide the information that is needed for sound economic decision making. The main purpose of financial accounting is to prepare financial reports that provide information about a firm"s performance to external parties such as investors, creditors, and tax authorities. Managerial accounting contrasts with financial accounting in that managerial accounting is for internal decision making and does not have to follow any rules issued by standard-setting bodies. Financial accounting, on the other hand, is performed according to Generally Accepted Accounting Principles (GAAP) guidelines.
CPA"s

The primary accounting professional association in the U.S. is the American Institute of Certified Public Accountants (AICPA). The AICPA prepares the Uniform CPA Examination, which must be completed in order to become a certified public accountant. To be eligible to become a CPA, one needs an undergraduate degree in any major with 150 credit hours of course work. Of these 150 credit hours, a minimum of 36 credit hours mustz be in accounting. Only about 10% of those taking the CPA exam pass it the first time.