Advantages Of Using Accrual Accounting Instead Of Cash Accounting

The main contrast between cash accounting and accrual accounting is timing. Cash accounting records income and expenses as earned, and accrual accounting allows to see the current state of a company’s finances by being more perspicacious. Accrual accounting allows income and expenses to be registered when they occur, not when money is physically received in the cash register. This type of accounting allows for more up-to-date planning and precise future periods’ finances calculation.

One of the firm assets’ examples is the property lease asset, divided into intervals in which payment is made in the accrual method. In the cash-based accounting method, payment for the entire year can be accounted for in the month when the actual transaction occurred, although the property is used and benefit all year round. Expenses, for example, payment for utilities, are also not accounted for using the cash-based accounting method until the fact of payment is confirmed, and the firm cannot even recognize its liability in the long term. However, the cost of the utilities would have already been recognized and accounted for within the accrual model.

Furthermore, the cash method does not consider long-term liabilities, which are considered in the accrual method, for example, a bank loan. Revenue on a cash basis refers specifically to transferring money from hand to hand, such as a customer paying for a particular product. If the payment is made on the spot, it would appear the same in both methods, but if the payment is made on an invoice basis, the cash accountment will tie it to the moment the money is received, not to the moment the transaction takes place.

If additional PPE (property, plant, and equipment) needs to be acquired, their expenditure may not be justified and may not be reflected in earnings. Since the acquisition of such assets is not a one-step transaction, the benefit or loss from their acquisition will not be evident using the cash model. In the case of step-by-step monitoring with the accrual model, the financial implications of acquiring PPE will be more noticeable and could contribute to increased revenue.

The main disadvantage of the accrual accounting method for a small business is that this method is more time-consuming and complicated than the cash accounting method. Sometimes it requires hiring an additional employee because it includes unearned revenues and prepaid expenses. It also does not account for cash flow, which can lead to the problem of cash shortages in a short period with overall profitability in more extended periods of time.

The main recommendation for using the accrual method is that a more straightforward strategy for future development will be perceptible. With this method, the long-term benefits will be visible, and possible unprofitable liabilities or expenditures will become more apparent. When utilizing the model, it will be possible to have a view of the company’s current state without any unexpected events. The company’s capabilities in this model will also be more significant and more predictable.