14.1 Cash vs Accrual accounting
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This document compares cash accounting and accrual accounting. Cash accounting measures profit based on cash received from revenue and cash paid for expenses. Accrual accounting measures profit based on revenue earned and expenses incurred regardless of when cash is received or paid. Accrual accounting provides a more accurate measure of net profit as it accounts for transactions that occur across reporting periods. Examples are provided to illustrate the differences between cash and accrual accounting treatment of transactions like prepaid expenses, credit sales, and depreciation.
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14.1 Cash vs Accrual accounting
- 2. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Profit can be determined with either: Cash Accounting: measures profit by determining whether cash has been received or paid. No cash changing hands means no Revenue or Expense. Accrual Accounting: measures profit by determining whether the business has earned Revenue or incurred an Expense. Whether cash has changed hands is irrelevant. Accrual accounting is the preferred method for most businesses as it is a more accurate measure of Net Profit. Why? 14.1 CASH VS. ACCRUAL ACCOUNTING Profit in Cash Accounting = Revenue Received -- Expenses Paid Profit in Accrual Accounting = Revenue Earned -- Expenses Incurred
- 3. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Many transactions overlap reporting periods, e.g. a firm’s reporting period runs for 6 months from 1 January to 30 June. On 1 January the firm pays $1,200 (plus GST) for insurance for the next 12 months 30 June Profit calculated for 6 months here J F M A M J J A S O N D 1 January Paid $1200 for 12 months insurance Cash Accounting Expense = Expenses Paid Accrual Accounting Expense = Expenses Incurred$1200 $600 1200100 100 100 100 14.1 CASH VS. ACCRUAL ACCOUNTING 100 100 Reporting Period
- 4. © Michael Allison, Trinity Grammar School. Author’s permission required for external use E.g. During March a business had credit sales of $2,000 – the debtor won’t pay for another 6 weeks. In addition, a debtor from February repaid $600. Cash Accounting Revenue = Revenue Received Accrual Accounting Revenue = Revenue Earned$600 $2000 14.1 CASH VS. ACCRUAL ACCOUNTING February March February Credit Sale $600 Collected in… March Credit Sale $2,000 Collected in… Reporting Period
- 5. © Michael Allison, Trinity Grammar School. Author’s permission required for external use E.g. Depreciation on the firm’s vehicle for November was $250 November Cash Accounting Expense = Expenses Paid Accrual Accounting Expense = Expenses Incurred $0 $250 14.1 CASH VS. ACCRUAL ACCOUNTING Reporting Period
- 6. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Transaction Cash Accounting Accrual Accounting Cash sales Credit sales Cost of sales Expenses paid for in cash Expenses incurred on credit Receipts from debtors Payments to creditors Capital contributions of cash Drawings of cash 14.1 CASH VS. ACCRUAL ACCOUNTING
- 7. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Transaction Cash Accounting Accrual Accounting GST collected/paid Depreciation Discounts revenue/Discount expense Interest revenue/Interest expense Money borrowed from a bank (loans) Loan repayments Asset purchases for cash Stock gain/loss 14.1 CASH VS. ACCRUAL ACCOUNTING