Accrual versus Cash Accounting: What’s the Difference?

Although the benefits of the accrual method should by now be apparent, it does by definition have the limitation that analysts cannot track objectively the movement of cash.

Cash accounting objectively recognizes revenues when cash is received and records costs when cash is paid out; accrual accounting involves subjectivity in regard to the allocation of revenues and expenses to different periods (Exhibit 5.3).

Exhibit 5.3. Major Differences Exist Between Cash and Accrual Accounting
Cash AccountingAccrual Accounting

  • Purpose

Track movement of cash.Allocate revenues and expenses to create a more accurate depiction of operations.

  • Revenue Recognition

Cash is received.Economic exchange is almost or fully complete.

  • Expense Recognition

Cash is paid out (could be in a different period from revenue recognition).Expenses associated with a product must be recorded during the same period as revenue generated from it (matching principle).

  • Judgment

Movement of cash is objective.Allocation of revenues and expenses to different periods is subjective.

  • Key Takeaway

Under accrual accounting, some reven ues and expenses are reported in periods that are different from those in which cash was actually received or spent!

Public companies are required to use accrual accounting in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Cash accounting may be used by small businesses (e.g., a coffee shop) and is used by the U.S. federal government in its budget reporting.

The cash flow statement, one of the three principal financial statements and designed to track the movement of cash, allows analysts to reconcile the differences between accrual and cash accounting.

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