The cash basis accounting method calls for the recording of economic business events as cash is received or paid. Therefore, the cash method of accounting requires the reporting of revenues when cash is received from customers and payments are made for expenses.
The cost basis of accounting is one of two commonly accepted accounting methods, the other being the accrual method of accounting. While the cash method calls for the reporting of cash transactions as they occur, the accrual method requires the reporting of revenues as they are earned and expenses as they are incurred.
The accrual method of accounting follows the matching principle, which calls for the reporting of revenues and expenses in the same time periods in which they occur. For this reason, the accrual method is deemed more accurate than the cash basis of accounting.
The systems and processes required to support the accrual basis are more complex than the cash basis, which is far easier to implement. This explains why many new and smaller businesses (under $5,000,000 in revenues) often choose the cash basis.
Taxpayers are permitted to use the cash basis when filing income tax returns. However, once a method is chosen, the taxpayer needs to be consistent from year-to-year.
Company A hires a general contractor to build out two new office spaces in an existing building over the next six months. The total vendor cost of the project will be $60,000, and the payment schedule calls for upfront cash of $10,000, with the remaining balance to be paid upon completion of the project.
The cash basis of accounting would require the recording of two transactions: the initial payment of $10,000 and the final payment of $50,000 six months later. The accrual basis of accounting would require the recording of six transactions: $10,000 per month for six months.