Cash vs. Accrual
Accounting System

Before we discuss accrual accounting let’s discuss cash accounting first.

Cash accounting is the simplest method of keeping track of money. It is simply recording cash transaction when they occur. Cash transactions occur when money is deposited and withdrawn from a bank account or petty cash. Petty cash is money stored outside of a bank. It can be your wallet, mattress, safe, or a tin can in your closet. When money is deposited or withdrawn from a bank account or petty cash it is recorded in a journal.

For example Ben has $100. He buys $10 of groceries from the local store. After arriving home, he writes in his journal, I spent $10 on Groceries at local store on today’s date. My remaining balance is $90.

Simple right?

Now let’s look at a different scenario with Ben the next day. Ben has $90. He is at the hardware store looking for a toilet. A new toilet costs $100. Ben doesn’t have enough cash to buy it but remembers he has $200 of available credit on a credit card. He buys the toilet for $100 on his credit card. He goes home and installs the toilet.

He doesn’t record the transaction in his journal, because $100 cash was not withdrawn from his bank account. He still has $90 in the bank. Ben has approximately 30 days to pay his credit card company $100. Only at that time will the $100 be withdrawn from the bank. So, the problem with cash accounting is the recording of future transactions such as purchases on credit.

This is where accrual accounting succeeds. Accrual basis accounting tracks obligations (payables) to pay cash in the future. Where cash accounting tracks the movement of cash only. No cash exchange, no need to record.

So let’s return to the second scenario of Ben at the hardware store. Ben needs the toilet so he buys it on credit for $100. Knowing he has an obligation to pay the credit card bill in 30 days. When he arrives at home, he writes in his journal. On today’s date, I bought a $100 toilet on credit to be paid in 30 days. In addition he writes the same transaction in a second book (ledger) called an Accounts Payable.

As shown in Figure 2, accrual basis accounting involves at least two entries. However this task is easy with accounting software. The second entry is automatic after selecting the account ledger on the journal entry form.

The difference between the two systems is how the income statement is treated. In a cash basis the Income Statement and Cash flow Statement are the same. With accrual basis the Income and Cash Flow Statement are not equal because transactions are recorded when earned not when received. For this reason the U.S. government requires accrual basis accounting to report income for businesses that keep an inventory.

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