When you start a business, you will need to choose between accrual and cash accounting. Even if you have a CPA in Las Vegas do the accounting for you, it is still your choice to make. The choice affects how you handle income taxes, deductions and other aspects of your company's finances. Understanding the differences between these accounting practices will help you make an informed decision.
What Cash Accounting Is
Cash accounting is the practice of recording money when it changes hands. Income is recorded when you receive the money, and expenses are recorded when you pay the amount due. For example, if you perform a service for a client on October 1, and the client pays on October 30, you count the income on October 30. For an expense, you count a bill on the date that you pay it.
What Accrual Accounting Is
Accrual accounting is the practice of accounting for the money as soon as the transaction is established. For example, if you perform a service on July 1 and send the bill on July 2, you count the income on July 2. This is the case even if the customer does not pay you until August 1. For an expense, you count the deduction of money on the date you receive the bill rather than the date that you pay it.
Making a Choice
Many small businesses choose cash accounting because it is simpler and easier to follow. However, the Internal Revenue Service requires that you use an accrual method of accounting if your business has an annual income of more than $5 million. You must also use the accrual method of accounting if you have a stock of inventory valued at $1 million that you sell to the public.