This video will cover the differences between Cash, Accrual, & Hybrid Accounting Methods. Check out the uTDu channel for more start-up, entrepreneurship, accounting and tax topics! CLICK HERE
Tax rules simply specify that businesses must use an accounting system that clearly reflects the income and expenses of the businesses and that this system must be used to maintain accurate and complete records on a regular basis. The two main methods are Cash Method and Accrual Method. There is also the Hybrid Method, which combines aspects of these two methods and is also explained in this video.
Most individuals use Cash Method, without even knowing it! Cash Method (also called Cash Basis) records income in the accounting records when cash is received and records expenses when they are paid. Therefore, this method is based on the exchange of cash.
On the other hand, Accrual Method (or Basis) removes the affects of the exchange of cash. Instead, with this method, income is simply recorded once the business has earned the income and expenses are recorded once they have been incurred.
Under accrual, cash received and cash payments are still recorded - of course! But, they do not affect understanding how the business is operating; meaning how much income has been earned and the related expenses of earning that income. Accrual method provides a clear picture of how profitable the business actually is by matching revenue and expenses. For these reasons, accrual method is required by the Securities and Exchange Commission (SEC) for public companies listed on public stock exchanges, like the NYSE. Often investors, banks and franchisors may want to see accrual records, as well.
The IRS provides a publication explaining these methods, Pub 538 Accounting Periods and Methods. CLICK HERE to check it out!