Expense now or expense later? The difference between cash and accrual basis accounting.

When it comes to accounting, the two most commonly used methods are cash and accrual basis accounting. Knowing the difference between the two is essential for any business looking to make informed decisions.

What is Accrual Basis Accounting?

Accrual basis accounting is a method of recording transactions when they are incurred instead of when cash is exchanged. This method is used by businesses who are looking to get an accurate picture of their profits and losses in their proper period. Under accrual basis accounting, expenses are recorded when they are incurred instead of when they are paid out.

This is much different than cash basis accounting. 

What is Cash Basis Accounting?

Cash basis accounting is a method of recording transactions when cash is actually exchanged. This method is used by businesses who want to focus on cash inflows and outflows instead of the profit or loss of the company. Under cash basis accounting, expenses are recorded when cash is actually paid instead of when the expense is incurred. The same goes for revenue - when cash is received from customers the revenue is recognized. 

Expense Timing: Cash vs. Accrual

When it comes to expense timing, cash and accrual basis accounting take different approaches. Cash basis accounting is focused on the actual cash that is exchanged, while accrual basis accounting is focused on the time an expense is incurred.

For example, if you pay a vendor for services rendered in June, but the services were actually performed in May, cash basis accounting would record the expense in June, while accrual basis accounting would record the expense in May.

So, the key difference between the two types of accounting is in the timing of when expenses are recorded. 

Which Method is Better?

Ultimately, the decision of which accounting method to use depends on the type of business you have and the information you need to make informed decisions. If you want to focus on cash inflows and outflows, then cash basis accounting may be the best option for you. However, if you need a more accurate picture of your profits and losses, then you may want to consider accrual basis accounting.

One consideration is that the Canada Revenue Agency (CRA) expects that almost all businesses use accrual basis accounting, but a lot of businesses will convert their accounting from cash to accrual basis at the end of the year to align their financials for completing their tax return. This can generally meet the CRA’s needs when filing taxes because across a fiscal year all transactions will be accounted for in that year they relate to. But, if you want to play it safe then use accrual basis accounting.

No matter which accounting method you choose, it is important to understand the difference between cash and accrual basis accounting and how it can affect your bookkeeping and accounting. By understanding the implications of each method, you can make better decisions when it comes to managing your finances and evaluating your company's performance.

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