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Cash vs Accrual Basis Accounting - The Profit/Loss Effect


Businesses typically use one of two accounting methods, cash or accrual, to record transactions, calculate profit or loss, and assess income taxes. Each method will produce a different bottom line number. The Internal Revenue Service (IRS) requires some businesses to use the accrual method; for example, those that carry inventory over certain levels. If your business is able to choose the method it uses, it is important to understand how taxable income is determined under each method.

The cash method of accounting recognizes income and expense when cash is received or expensed and the balance sheet does not contain the accounts receivable or accounts payable under this method. For example, if you purchase goods on account at the end of the year and don't pay for them until the following year, you would not be able to deduct that expense until the following year when payment is made.

The accrual method of accounting recognizes income and expense when the sale is made or the expense is incurred, regardless of when cash changes hands. For example, if you sell your products on account, any sales made at the end of the year where payment is received in the following year would be included as income during the year the sale is made.

Here's a simple example of the difference in profit under the cash and accrual methods assuming the following takes place at the end of the year for ABC Consulting Services:

  1. Services performed in December totaling $10,000 are billed to customers and payment is received in January.
  2. Office supplies are purchased on account in December for $500.
  3. Newspaper advertising is ordered in December for $1,000, paid in January.
  4. Wages and payroll taxes for the last week of December will be paid in January.

ABC Consulting Services

Profit/Loss Statement


Service Revenue

Cash Basis
$ 150,000

Accrual Basis
$ 160,000

$ 10,000





$ 4,000

$ 5,000

$ 1,000

Office Supplies

$ 2,000

$ 2,500

$ 500


$ 3,000

$ 3,000

$ -


$ 70,000

$ 71,500

$ 1,500

Payroll Taxes

$ 7,000

$ 7,150

$ 150


$ 2,500

$ 2,500

$ -


$ 600

$ 600

$ -

Total Expenses

$ 89,100

$ 92,250

$ 3,150


$ 60,900

$ 67,750

$ 6,850


The difference in taxable profit is $6,850. Under the accrual method the service revenue is recorded as well as office supplies, newspaper advertising, and wages and payroll taxes, even though cash is not received or paid until the next year. This example results in a higher taxable income under the accrual method, but that may not always be the case. Depending on your type of business, timing of cash flows, and other factors, one may be a better choice for you.

The use of small business accounting software makes it easier to calculate the differences between cash and accrual because most allow you to enter all transactions and then generate reports under both methods. This is extremely important when you want to maintain accounts receivable records for your customers, but choose to use the cash method of reporting for income tax purposes.

It is best to choose the method that is right for your business, provided you have that option, and stick to it. The IRS will allow you to change accounting methods, but you must get their approval first by filing Form 3115, Application for Change in Accounting Method, and there can be fees involved.


This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.