Cash accounting and accrual accounting differ in how they record income and expenses based on timing. With cash accounting, transactions are recorded when money is exchanged. In contrast, accrual accounting records transactions when invoices are raised or bills are received, regardless of actual money exchange.
Example
- Cash accounting: If you invoice ÂŁ1,000 on 1st May but receive payment on 15th August, you record the ÂŁ1,000 on 15th August when payment is received.
- Accrual accounting: In the same scenario, you record the ÂŁ1,000 on 1st May when the invoice is raised.
Cash Accounting:
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Benefits:
- Simplicity.
- Income tax is paid only when money is received, offering flexibility.
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Drawbacks:
- May not accurately reflect a company's health, especially if upcoming expenses are significant.
Accrual Accounting:
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Benefits:
- Provides a clearer picture of business performance and health.
- Allows more confident financial decision-making.
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Drawbacks:
- Offers an inaccurate short-term view due to accounting for all upcoming transactions.
- May result in paying taxes on income not yet received.
For more information on tax implications, refer to the HMRC website.