Accrual Method vs. Cash Method in Bookkeeping
Can someone give me a logical clear explanation of what cash vs. accrual method i in bookkeeping? For example: if a construction company has a client that needs a service and he is paid half up front the day the job begins but the other half is paid when the services are complete, is that cash or accrual or both?
There are many good explanations out on the Web that cover this pretty well to which I refer you for a more complete explanation.
But to get you started in more layman's terms, cash accounting is when you keep the books like your home check register. Your checking account register shows your asset balance. When you write a check, you subtract the amount from your balance in the register. When you make out a deposit, you add the amount to your balance in the register. Transactions affect your Net Income (Assets - Liabilities) on the Balance Sheet when the money ("cash") actually goes out and comes in. Your assets and liabilites on the balance sheet change when the cash money comes and goes.
Accrual accounting is recording transactions when the obligation occurs. I.e., when you receive a bill from the vendor due in 30 days, you enter it in the books, and it becomes a "payable". You now have a liability on the balance sheet which reduces your Net Income. Transactions affect your Net Income (Assets - Liabilities) on the Balance Sheet when the obligation to pay (or to receive payment) is recorded (when it is "accrued").
Why would you use one over another? I think there is a myth that Cash accounting is more simple than Accrual, and in some sense that's true. But after 5 years on QuickBooks using both, I see no difference. (Now my experience is with small nonprofits, so others may have different observations.) But it's mostly inconsequential in the bookkeeping part, but there can be a big difference in the balance sheet report between the two. If you have a mall club or solo business, Cash accounting could be fine.
If you have anything larger, I recommend Accrual, especially if your revenue and corresponding expenses can be in different fiscal years. For example, you can expend funds from a grant, for example, all year and then submit the reimbursement request on Dec 31. It will be recorded in your books as a receivable and show up on the balance sheet in that year, matching the expenses, even though you won't receive payment until January. Likewise, you can purchase a pile of inventory in December, but not get the revenue from sales till the next year. In a Cash scheme, the recording of when the expenses occur and when the revenue comes in to match those expenses are in different years. Your balance sheet could show a big loss for the fiscal year, even though that's not the case.
Hope that helps some. Others with more experience than my self-taught 5 years can chime in to correct or supplement.
Cash or accrual have nothing to do with how a client pays you, it has to do with how income and expenses are recognized in your accounting program.
See my answer to your other post on this subject.
@Dennis Fazio Thanks so much for that explanation. So for my business (small construction company), I enter in QBO invoices for my clients and tie the payments received to those invoices. That then leaves an A/R in my balance sheet so then I would use the accrual method, correct? I don't pay bills directly from my QBO account at all. Is that also what I should be for tax purposes as well?
@terri-20: If you are entering invoices and bills and paying for or receiving payment for them later, then you should be using accrual. Accrual will give you a more accurate view of your businesses' financial situation.
In QBO, there's really no significant operational difference between cash and accrual. If you're using cash, you can still enter bills and invoices prior to payment, just as you do in accrual. The only difference you will see is in the balance sheet. In fact in QBO, cash vs accrual really only affects the reporting. You can switch back and forth between cash and accrual dynamically right in the report parameters when creating any P&L or Balance Sheet report.
The only thing that's not obvious with Accrual is what your cash situation might be. You could be great on the balance sheet with high receivables, but it won't tell you when you might overdraw your checking account. This is where the cash flow report comes in. But usually if your business isn't too complicated, and you maintain a healthy checking account balance to cover a couple of months worth of typical bills, you should be fine. I've never had to run a cash flow report for my nonprofit clients (most boards wouldn't understand it anyway); it was always pretty obvious if they might be short on cash soon.
You should set up the bill pay feature in QBO so you can pay bills with bank-to-bank transfers or mailed checks. They integrate either with Bill.com (~$1 per payment) or a new partner, Melio, that provides free payments for ACH and checks.
You should also read up more on the basics of accounting & bookkeeping to fill in the gaps of your knowledge and go through the QBO free tutorials and training videos which help explain the flow of things in QBO.
@terri-20: Accrual vs Cash doesn't affect taxes except for the check box on the return where you state whether you use Cash or Accrual.