Studio One Networks: Real Small Business

Studio One Networks: Real Small Business:

"What is cash basis accounting?

Most small businesses use the cash basis method of accounting, which is based on real-time cash flow. In cash method, you report an expense when it is paid, and record income when it is received. So, the day you receive a check, it becomes a cash receipt. And you record your expenses when you pay your bills, not when the bill is received.

By the way, the word 'cash' is not meant literally -- it also covers payments by check, credit card, barter, etc.


What is the accrual method of accounting?

With accrual accounting, you record income when it is earned, not when it is paid. Similarly, you record your expenses when the obligation arises, not when you pay it. The tax code refers to this as recording income and expenses when they are 'fixed' - when all the necessary events have occurred to receive the income or expense the liability. It is not necessary for cash to change hands.

Here's how accrual would work. Say, for example, you're a consultant and you complete a job on December 15, but you haven't been paid for it. You recognize all expenses in relation to that contract when they were incurred, regardless of whether you've been paid yet or not. Both the income and expenses are recorded for the current tax year, even if payment is received and bills are paid the following February.
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