Let’s first explain the difference by their accounting definition:
Cash based accounting – is when an organization writes the check out and the expense is realized at the time the check is written. Revenues are reported on the income statement in the period in which it was received by the client.
Accrual based accounting – is when the expenses are reported on the income statement in the period when they occurred or when they expire. Many times this period is different from when the payment is actually made. Revenue are reported on the income statement when they are earned. The period when the cash is received (physically) is typically different then when the revenues were reported earned.
Here is a simple example:
Cash Based Accounting – You hire a contractor to come do some yard work on May 31st. He finishes his work by COB (Close of Business) and he gives you the bill for his work. You write a check and pay him on the spot. The expense was realized by you when he handed the bill to you and you wrote out a check.
Accrual based Accounting – You hire a contractor to do some yard work and he comes on May 31st. He leaves a bill for you at your door. He records his revenue on May 31st because that is when the revenue for him was ‘earned’. It was not paid by you until June 10th. However, for you the expense would show up on May 31st – not June 10th. Therefore the cash physically leaves the organization on June 10th but the expense was recorded on May 31st. The liability account will show the money owed for this contractor between the dates May 31st through June 10th.
Advantages and disadvantages of using cash or accrual accounting (ref. www.sba.gov )
Cash Based Accounting – When you consider using cash accounting, understand the following advantages and disadvantages for your church:
- Accurate Tracking of Cash Flow. Cash accounting gives an accurate reflection of your cash flow. Since it only records revenue and expenses when they actually appear in your account, you know how much cash you have on hand in the particular moment.
- Inaccurate Representation of Long-Term Revenue & Expenses. While cash accounting accurately tracks cash flow, it gives a false impression of your revenue and expenses. For example, if your business generated a lot of revenue in 2009, but payment for that revenue was not received until 2010. As a result, your business shows negative cash flow, even though you anticipate receiving payments.
- Less Bookkeeping. Tracking your business account is fairly straightforward – transactions are recorded only when cash leaves or enters your account.
Accrual based Accounting – When you consider using accrual accounting, understand the following advantages and disadvantages for your business:
- Accurate Tracking of Long-Term Revenue & Expenses. An advantage of accrual accounting is a more accurate picture of your operations. For the specified time period, you see how much business you have done and what expenses you have incurred.
- Inaccurate Representation of Cash Flow. Accrual accounting encounters the opposite problem of that of cash accounting: inaccurate representation of your cash flow. You may have closed a lot of sales that particular year, but if your customers have not paid you, you do not have the money in your account. In other words, even though your business has generated a lot of revenue, you do not have the cash for those sales.
- More Bookkeeping. For cash accounting, you only need to record when you make or receive a payment. For accrual accounting, you would record both the transaction date of the sale and the date of received payment.
Most churches use Cash based accounting. In IconCMO, the banking module is used for cash based accounting. AP (Accounts Payable) is used for accrual based accounting and for setting up vendors. Some churches make the mistake and use AP instead of banking when setting up the accounting for the church. If you encounter any questions when setting up your accounting records in IconCMO, call our tech support department at 218.236.1899 or email us at firstname.lastname@example.org.