What is Cash Accounting?

The IRS requires that accounting be conducted with either the cash method or the accrual method of accounting.  The cash method is very simple where as the accrual method is much more involved.

The cash method of accounting simply means that sales and expenses are recorded when cash is spent or received.  This makes recording expenses very easy.  For example, ABC Auctions had $100 in eBay fees charged to their credit card.  When the credit card statement arrives the bookkeeper pays the bill and records $100 into the Ebay Fees expense account.  Done and simple!

The cash method of accounting can be compared to a home finance situation.  When a utility bill is paid the expense is recorded when the bill is paid even though some of the utility was probably consumed from the previous month.

Cash accounting is normally performed in a single entry accounting program.  This means that each transaction has one entry.  For example, when paying eBay fees the amount paid is recorded in the Expense Journal as one entry.  

When charging items to a credit card using the cash method of accounting the total due should be paid in full each month.  This keeps bookkeeping within cash accounting simple.  For example, ABC Auctions charged eBay fees of $50 and purchased office supplies for $50 on the same credit card.  When the credit card statement arrives the bookkeeper decides to only pay the minimum due, which is $10.  In cash accounting expenses are recorded when paid.  What expense will the bookkeeper record for $10?  The best way to handle this situation is to pay at least one expense in full.  The bookkeeper should send the credit card company $50 and record either the eBay fees or the office supplies.  This is precisely why it is best to pay all credit card balances in full, or at least pay off one entire expense.

Since cash accounting records all expenses when cash is paid it is not ideal to carry a lot of debt. The IRS probably will not fuss if you acquire some debt but if you normally carry large balances on credit cards or to vendors then the cash method of accounting may not be the method for you to use.  

What is Accrual Accounting?

The accrual method of accounting means that sales and expenses are recorded when they occur and not when cash is affected.  Accrual accounting is performed in a double entry accounting program.  This means each transaction has at least two entries.  For example, when dealing with eBay fees, if the fees are charged to a credit card, the amount is entered as an increase to the credit card account and the amount is also entered as an increase to the expense account Ebay Fees.  Then when the credit card is paid the credit card account is decreased and the asset account Cash is decreased.  

Most large corporations use the accrual method because many expenses such as payroll, prepaid insurance, and asset depreciation has to be considered.  Most small home businesses do not use the accrual method because it is more complex. Accrual accounting is more involved because it considers assets, liabilities, and owner's equity into each transaction.

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