Crash Course in Accounting and Financial Statement Analysis, Second Edition

Accrual versus Cash Accounting: What’s the Difference?

Although the benefits of the accrual method should by now be apparent, it does by definition have the limitation that analysts cannot track objectively the movement of cash.

Cash accounting objectively recognizes revenues when cash is received and records costs when cash is paid out; accrual accounting involves subjectivity in regard to the allocation of revenues and expenses to different periods (Exhibit 5.3).

Exhibit 5.3. Major Differences Exist Between Cash and Accrual Accounting

Cash Accounting	Accrual Accounting
Purpose	Track movement of cash.	Allocate revenues and expenses to create a more accurate depiction of operations.
Revenue Recognition	Cash is received.	Economic exchange is almost or fully complete.
Expense Recognition	Cash is paid out (could be in a different period from revenue recognition).	Expenses associated with a product must be recorded during the same period as revenue generated from it (matching principle).
Judgment	Movement of cash is objective.	Allocation of revenues and expenses to different periods is subjective.
Key Takeaway	Under accrual accounting, some reven ues and expenses are reported in periods that are different from those in which cash was actually received or spent!

Public companies are required to use accrual accounting in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Cash accounting may be used by small businesses (e.g., a coffee shop) and is used by the U.S. federal government ...