Learn Finance - Accrual and Cash Accounting

CASH & ACCRUAL ACCOUNTING

Yiannis Megaloeconomou, MBA

LEARNING OUTCOMES

• What is cash and accrual accounting?

• What is their main difference?

• Examples on cash and accrual accounting on sales revenue and expenses

• Advantages and disadvantages of cash and accrual accounting

• Practicing cash and accrual accounting

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Cash versus Accrual Accounting

Cash and accrual accounting are the two

principal methods for recording income

(sales revenue) and expenses for a business

The difference between the two accounting

methods is when (the time) revenue and

expenses are recognized

Cash & Accrual Accounting Yiannis Megaloeconomou, MBA

Cash Accounting

• Recognizes revenue at the time

payment has been received no matter

when the sale was made

• Recognizes expenses at the time

payment for goods and services has

been made regardless of whether the

expenses were incurred or not


Cash Accounting

Revenue Recognition example 1

When a business delivers goods to a customer in January and payment is received in February, then revenue will be recorded at the time of payment received, meaning in FebruaryCash & Accrual Accounting

January February

GoodsDelivered

PaymentReceived

$$

Record Sale $$


Cash Accounting


When a business delivers goods to a customer in February and payment has been received a month earlier in January, then revenue will be recorded at the time of payment received, that is in JanuaryCash & Accrual Accounting

January February

GoodsDelivered

$$

PaymentReceived

Record Sale $$


Cash Accounting

Expense Recognition example 1

In case an employee worked for a business during

March and payment for his/her services has been

made in April the salary expense for the employee

will be recorded in April, at the time of paymentCash & Accrual Accounting

March April

ServicesReceived

PaymentMade

$$

Record Expense $$

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Cash Accounting


In case an employee worked for a business during March and payment for his/her services has been made a month earlier in February, then the salary expense for the employee will be recorded in February, at the time of payment

Cash & Accrual Accounting

February March

ServicesReceived

$$

PaymentMade

Record Expense $$


Accrual Accounting

Recognizes revenue at the time goods or

services are delivered no matter when

payment is received

Recognizes expenses at the time

expenses are incurred no matter when

payment is made


Accrual Accounting


When a business delivers goods to a customer in

January and payment is received in February, then

revenue will be recorded at the time they were

earned, that is in JanuaryCash & Accrual Accounting

January February

GoodsDelivered

PaymentReceived

$$

Record Sale $$


Accrual Accounting


Receiving Advance PaymentsA business receives payment from a customer in January but services will be rendered in FebruaryIn this case revenue cannot be recorded in January Instead, the business has created for itself a liability to its customerRevenue will be recorded once the business provides services to its customer in FebruaryCash & Accrual Accounting

January February

ServicesProvided

$$

PaymentReceived

Record Sale $$








Accrual Accounting


In case an employee worked for a business during March and payment for his/her services has been made a month later in April, then the salary expense for the employee will be recorded in March, at the time of employee services


March April

ServicesReceived

PaymentMade

$$

Record Expense $$


Accrual Accounting


Making Advance Payments (prepayments)You prepay an employee in February $1000 for his March salary

In this case the business cannot record the $1000 as a salary expense in February since the expense has not been incurred yet

The business records a service claim from the employee

Once the employee works for the month of March it may record it in its books as a salary expense


February March

ServicesReceived

$$

Paymentmade

Record Expense $$

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Cash Accounting - Advantages

1. Easy to use due to its simplicity and less regulation

to follow

• Since it’s based only on cash transactions

2. It keeps a good record of cash transactions

• Inflows and outflows from operations

3. Good for businesses that do not operate on a credit

basis

• They receive and pay within the same period

their revenue and expenses respectively


Cash Accounting - Disadvantages

1. It does not record receivables

• E.g. If you deliver goods to a customer in

January and the agreement is to receive

payment for these goods in February, at the

end of January there is no accounting record

of the money that you expect to receive from

the customer in February


2. It does not keep track of payables

• E.g. If you receive goods in January from

a supplier and you agree to make

payment of these goods in February,

there is no record in the books of this

obligation that you have to meet in

February



3. It does not track partial payments

• Let’s say you have agreed to receive

payment from a customer in three

installments, $1000 in January, $1000 in

February and $1000 March. At the end of

January, there is no accounting record

saying that two payments of $1000 are

still expected to be received in February

and March, since cash accounting does

not keep track of the receivables for the

following two months



4. There is no matching of expenses and their related

revenue during the same period

• E.g. An advertising agency works on a marketing project

for a customer for the entire month of January. All

expenses for the agency’s marketing project amount to

$1000 and are paid in full by the end of January. The

project is submitted to the customer by the end of January

at a sales price of $2000. However, payment is received in

February.

• The project’s expenses of $1000 will be recorded in

January and its $2000 of sales revenue in February

• Therefore, there is no match of the revenue and their

related expenses during the same period



5. Operations and results are not

accurately recorded

• Let’s say you sell and deliver goods to a

customer in February at a sales price of

$2000. Payment for the these services

(operations) is received in March.

• The actual operations (services) took

place in February but sales (results) are

recorded at a different time period in

March



Accrual Accounting - Advantages

1. It keeps track of receivables

• For example when services are provided to a

customer on credit you record both sales

revenue and customer’s expected payments

(receivables)

2. It records payables

• When a business buys goods on credit from a

supplier, it keeps a record of its liability

(payables) to its supplierCash & Accrual Accounting Yiannis Megaloeconomou, MBA

3. It keeps track of partial payments

• Let’s say you have agreed to receive

payment from a customer in three

installments, $2000 in January, $2000

in February and $2000 March. At the

end of January, there will be an

accounting entry stating that two

payments of $2000 each are still to

be received in February and March



4. It keeps reports of cash

transactions

• Since it records both cash and

non-cash transactions, such as

receivables and payables


Cash & Accrual Accounting Yiannis Megaloeconomou, MBAJoin my Udemy Course (link)




5. It matches expenses and their related

revenue • E.g. An advertising agency works on a marketing

project for a customer for the entire month of

January. All expenses for the agency’s marketing

project amount to $1000 and are paid in full by the

end of January. The project is delivered to the

customer by the end of January at a sales price of

$2000. However, payment is received in February.

• The marketing project’s expenses of $1000 and also

sales revenue of $2000 will be recorded in January

since it tracks expenses and revenue at the time of

service



6. Operations and results are accurately

recorded• Let’s say you sell and deliver goods to a customer

in February at a sales price of $2000. Payment

for the these services (operations) is received in

March.

• The actual operations (services) and sales

revenue (results) are recorded at the same time

since both took place in February



Accrual Accounting - Disadvantages

1. It is a more complex accounting methods

since it goes far beyond cash

transactions

2. It’s subject to more rules and regulations

since it necessitates some estimations

• For example, a business needs to estimate

some expenses such as depreciation

expenses, receivables that will never be

collected, etc.Cash & Accrual Accounting Yiannis Megaloeconomou, MBA

Things to Remember

• Cash & Accrual Accounting are 2 different

methods for recording sales revenue &

expenses

• Usually small and medium size businesses use

cash accounting while larger businesses apply

accrual accounting

• Each method uses a different approach,

however accrual accounting makes more

business sense since it matches much better

operations with revenue and their associated

expenses during a periodCash & Accrual Accounting Yiannis Megaloeconomou, MBA







Practicing

For practice there are available problems to

download on cash and accrual accounting

along with their solutions


Economy & Finance

Learn Finance - Accrual and Cash Accounting