Cash vs. Accrual Accounting:
While it is beyond the scope of this module to assess accounting systems against all types of accounting styles, it is important that managers understand the differences between cash accounting and accrual accounting.
Accrual accounting can be characterised by:
- Revenue / income being recorded when it is earned, not when it is received. In the real estate context it could be said that the sales commission is earned when the contract becomes fully enforceable, however the agency will not actually receive the commission until the settlement date.
- Expenses are recorded when they are incurred, not necessarily when they are paid for. An example would be a building repair bill. The expense is incurred when the work takes place, however the bill may not need to be paid for 30 days.
Cash accounting on the other hand is characterised by:
- Revenue only being recorded when it is received by the office (the cash is actually received)
- Expenses are only recorded when they are paid for
Cash accounting is usually used in small business where expenses are generally paid at the time the particular service is actually provided.
The Australian Tax Office has recognised the advantages for small to medium size business in adopting the cash accounting formula. To this end, small to medium size business have the option of either method.
As there are significant differences in how the two accounting methods are used (and the tax position differs markedly), it is advisable that people considering whether to adopt a cash or accrual accounting method seek specialist advice relevant to their particular position.
For the purposes of this module, the cash accounting method is assumed where relevant.