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Imagine you run a small bakery. You sell cakes and receive payments immediately. But your supplier delivers flour today and asks for payment next month. How should you record these transactions? 🤔
If you use cash accounting, you record income only when the money enters your bank. If you use accrual accounting, you record income when you earn it, even if you haven’t received cash yet.
Let’s break down the differences and see which method is best for your business!
What is Cash Accounting?
Cash accounting records income only when cash is received and expenses only when paid. This method is simple and often used by small businesses that don’t deal with credit transactions.
Example of Cash Accounting
- A bakery sells a cake for ₹1,000 on January 10.
- The customer pays immediately in cash.
- The bakery records the sale on January 10.
But if the bakery delivers cakes to a corporate client who promises to pay in February, the revenue is not recorded until payment is received.
✅ Simple & easy to track
✅ Works well for small businesses
❌ Does not show outstanding revenues & expenses
What is Accrual Accounting?
Accrual accounting records income when it is earned, even if the payment comes later. Similarly, expenses are recorded when they occur, not when they are paid.
Example of Accrual Accounting
- The bakery sells cakes to a corporate client for ₹10,000 on January 10.
- The client will pay in February.
- The bakery records the revenue in January, when the sale happened.
Similarly, if the bakery buys flour on credit in January but pays in February, the expense is recorded in January, not in February.
✅ Gives a complete financial picture
✅ Required for large businesses & tax filings
❌ More complex to manage
Key Differences: Cash vs. Accrual Accounting
| Feature | Cash Accounting | Accrual Accounting |
| When is revenue recorded? | When cash is received | When earned (regardless of payment) |
| When are expenses recorded? | When paid | When incurred (regardless of payment) |
| Suitable for | Small businesses & freelancers | Large businesses, companies with credit transactions |
| Financial visibility | Only tracks cash flow | Shows full financial picture |
| Taxation impact | Tax paid only on received income | Tax may be due on earned but unpaid revenue |
What is the Journal Entry for Cash vs. Accrual Accounting?
Example 1: Revenue Recognition
A business provides consulting services worth ₹50,000 in December but gets paid in January.
Cash Accounting Entry (January – When Payment is Received)
Debit: Cash/Bank ₹50,000
Credit: Service Revenue ₹50,000
Narration: “Recorded ₹50,000 as service revenue on cash receipt.”
Accrual Accounting Entry (December – When Revenue is Earned)
Debit: Accounts Receivable ₹50,000
Credit: Service Revenue ₹50,000
Narration: “Recorded ₹50,000 as revenue in December, payment expected in January.”
When the client pays in January:
Debit: Cash/Bank ₹50,000
Credit: Accounts Receivable ₹50,000
Example 2: Expense Recognition
A business receives an electricity bill of ₹8,000 in December, but the payment is made in January.
Cash Accounting Entry (January – When Payment is Made)
Debit: Electricity Expense ₹8,000
Credit: Cash/Bank ₹8,000
Narration: “Paid ₹8,000 electricity bill in January.”
Accrual Accounting Entry (December – When Expense is Incurred)
Debit: Electricity Expense ₹8,000
Credit: Accrued Expenses Payable ₹8,000
Narration: “Recorded ₹8,000 electricity expense in December, to be paid in January.”
When the bill is paid in January:
Debit: Accrued Expenses Payable ₹8,000
Credit: Cash/Bank ₹8,000
Placement in Financial Statements
Balance Sheet Example (Accrual Accounting)
Accrued revenues appear under Current Assets, and accrued expenses under Current Liabilities.
Balance Sheet
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Credit (Cr) | Debit (Dr)
--------------------------------------
Liabilities | Assets
- Accrued Expenses ₹8,000 | - Accounts Receivable ₹50,000
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Profit & Loss Statement Example
Revenue and expenses are recorded in the period they are earned/incurred.
Profit & Loss Statement
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Credit (Cr) | Debit (Dr)
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Revenue | Expenses
- Service Revenue ₹50,000 | - Electricity Expense ₹8,000
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Which Accounting Method is Right for You?
| Business Type | Recommended Method |
| Freelancers & Small Businesses | Cash Accounting |
| Businesses with Credit Transactions | Accrual Accounting |
| Companies Required for Tax Compliance | Accrual Accounting |
| Startups Looking for Simplicity | Cash Accounting |
Common Mistakes to Avoid
🚫 Using cash accounting for a business that operates on credit.
🚫 Not switching to accrual accounting when required for tax compliance.
🚫 Mixing both methods, leading to incorrect financial statements.
Relevant Accounting Standards (GAAP, IFRS, IAS)
- IFRS 15 – Revenue Recognition (For accrual-based accounting)
- IAS 1 – Financial Statement Presentation
- US GAAP (ASC 606) – Revenue from Contracts with Customers
For more details, check GAAP vs. IFRS Differences.
FAQs
1. Which is better: Cash or Accrual Accounting?
✅ Cash accounting is simpler but may not reflect true profitability.
✅ Accrual accounting provides an accurate financial picture but is more complex.
2. Do small businesses need to use Accrual Accounting?
Most small businesses can use cash accounting, but if they deal with credit transactions, accrual is better.
3. Why does Accrual Accounting show revenue before payment?
It follows the matching principle, where income is recorded when earned, not when paid.
4. Is Cash Accounting allowed under GAAP?
❌ No, GAAP requires Accrual Accounting, but some small businesses may qualify for cash accounting exceptions.
5. Can a company switch from Cash to Accrual Accounting?
✅ Yes, but it requires proper adjustments and regulatory compliance.
Conclusion
Choosing cash or accrual accounting depends on your business size, complexity, and financial reporting needs. Small businesses prefer cash accounting for simplicity, while larger companies and tax authorities require accrual accounting for accurate financial reporting.