Accrual basis accounting differs from cash basis accounting in a few significant ways. To grasp these concepts, you need to understand how timing affects an accounting record.
You have four different ways to record revenue in relation to timing. These differences make up the foundation of the difference between accrual basis accounting and cash basis accounting.
Four Timing Differences
1. When revenue or credits are recognized on the general ledger before any actual cash is received, this is referred to as accrued revenue.
2. When expenses or debits are recognized on the general ledger before any actual cash is expended, this is referred to as accrued expense.
3. When revenue or credits are not recognized on the general ledger until the cash has actually been received and processed, this is called deferred revenue.
4. When expenses or debits are not recognized on the general ledger until the cash has been paid out, this is called deferred expense.
In accrual basis accounting, all revenues or credits and all expenses or debits are considered recognized when the revenue is earned, not necessarily when the revenue is in hand. For example, if your company sold 100 gadgets but was paid after the gadgets were shipped, your ledger may look like this:
January 1, 2009
January 15, 2009
Date of sale of $1000
Date $1000 Received
However, the credit of the $100 would be counted on January 1st, even though it had not yet been realized. A cash basis accounting system would record that $1000 on January 15th, the day the cash was realized.
When using an accrual basis accounting method, expenses can also be recorded when they are owed or before the business on the receiving end actually cashes the check or spends the money. As soon as the check is written to the other party, the amount is recorded as if it is gone, even if the other business waits a month to cash the check. The amounts of money being credited or debited are recorded at the times of the transaction arrangements, not necessarily at the date of the actual exchange of the money.
Accounting for outstanding checks can be time-consuming and troublesome, but you'll want to make sure you do so on a regular basis to prevent serious balance sheet reconciliation problems later.