February 16th, 2011 : Cash and Accrual Accounting
Cash and accrual accounting are the only two generally accepted accounting methods. The revenue your company earns will determine which method is used. Most small businesses will have the choice, however, there are certain circumstances where businesses are required by law to use the accrual method.
The cash system records accounting events when they become tangible, for example, when you receive a customer’s check, or when a shipped product reaches the customer. Under the cash accounting system, businesses record transactions at their end point. Revenue is recorded as it arrives, and costs are recorded as they leave the door. The cash accounting method is the most common accounting method used by small businesses and is the preferred method as well because it is straightforward. Income is taxable when it is received and expenses are deductable once they leave.
Under the accrual method, accounting practices are recorded in real time. Instead of documenting a transaction when you receive payment, the transaction is recorded once the customer signs the purchase order and vice versa when you purchase an item your costs are recorded once you sign the purchase order. It doesn’t matter whether it takes weeks or even months to close that transaction; the documentation of that transaction is recorded once the agreement of sale is made. The accrual accounting method is more accurate to the state of the business, however, it’s much more difficult to keep track of revenue and cost this way.
Mandate by Law
The accrual method is mandated by law when your company has more than $10 million in annual gross receipts. Your company is also mandated by law if your gross annual receipts are less than $10 million and over $1 million and your business activity can be classified as wholesale, retail, publishing, sound recording, or mining. If you are a partnership or tax shelter or if you are a farming corporation that meets certain IRS rules, you are also subject to the mandate.
Demir Barlas. Cash Versus Accrual Accounting for Small Businesses. Retrieved from http://sbinformation.about.com/lw/Business-Finance/Small-business-and-entrepreneurs/Cash-Versus-Accrual-Accounting-for-Small-Businesses.htm