Cash-basis accounting

Definition

Cash-basis accounting is a method where revenues and expenses are recorded only when cash is received or paid. This approach contrasts with accrual accounting, which records revenues and expenses when they are earned or incurred.

5 Must Know Facts For Your Next Test

1. Cash-basis accounting is simpler and often used by small businesses.
2. This method does not recognize accounts receivable or accounts payable.
3. It can give an inaccurate picture of long-term financial health.
4. Cash-basis accounting is not compliant with Generally Accepted Accounting Principles (GAAP).
5. The IRS restricts the use of cash-basis accounting for certain businesses, especially those that maintain inventory.

Review Questions

• What is the main difference between cash-basis and accrual accounting?
• Why might a small business prefer to use cash-basis accounting?
• What limitations does cash-basis accounting have in terms of financial reporting?

Related terms

Accrual Accounting:

A method where revenues and expenses are recorded when they are earned or incurred, regardless of when cash transactions occur.

Accounts Receivable:

Money owed to a company by its customers for goods or services already delivered.

Accounts Payable:

Money a company owes to suppliers for goods or services received but not yet paid for.