Two accounting methods exist for recording financial transactions--the accrual basis and the cash basis. The accrual basis records transactions, expenses and revenue as they occur, regardless of when cash is received. The cash basis records transactions only when cash changes hands from a transaction.

Requirements

Businesses must use the accrual basis if they meet two requirements--gross sales that exceed $5 million annually or when they sell inventory to the public that exceeds $1 million annually.

Adjusting Entries

The accrual basis of accounting generally requires less adjusting entries to close the general ledger at the end of an accounting period. Because transactions are recorded as they occur, no adjustments are necessary to balance the books for sales and cost of goods sold.

Better Reporting

Financial reporting is more consistent with accrual accounting. The accrual basis follows the principle of matching income with expenses, giving management an idea of how much money is required to obtain certain sales goals.

Tax Deductions

Accrual accounting can help businesses have higher tax deductions because expenses are recorded as they occur. Items recorded in the following year under the cash basis are deducted at year-end under accrual accounting, reducing the company's tax burden.

Cash Flow

One downside of accrual accounting is the lack of accurate cash flow reporting. To correct this, companies must prepare a separate cash flow statement to resolve cash flow problems.

Source:

All Business

Accounting Aide

Nolo