Changing from cash basis to accrual accounting can seem daunting, but it’s a necessary step for many businesses. This post will discuss what you need to know before making the switch. We’ll cover everything from the benefits of accrual accounting to the steps involved in transitioning. So if you’re considering making the switch, read on.
Difference between Cash Basis and Accrual Basis Accounting?
Cash basis accounting is a simple way of accounting where income and expenses are recognized when cash exchanges hands between a business and a customer. Cash basis can benefit small businesses that want to avoid complex bookkeeping procedures. However, cash-basis accounting can make it challenging to track your business’ financial health.
Accrual basis accounting provides a more accurate picture of your company’s financial health. This is because it records income and expenses earned regardless of whether cash has changed hands yet.
Benefits of Switching to Accrual
The benefits of using the accrual basis of accounting are many. Below are some of the key benefits:
Accrual basis accounting more accurately reflects a company’s financial position as it gives an accurate picture of cash available to meet obligations as they come due. As a result, accrual accounting is essential for companies that need to make informed decisions about whether they can afford new debt or expand their operations.
As a result, accrual provides a more accurate view of a company’s current financial state and its ability to generate future cash flow. Also, if your business has more than $25 million in average annual gross revenue, you’re required to use accrual basis accounting under Internal Revenue Service (IRS) rules.
Before Making The Switch
If you’re thinking about converting from cash to accrual, there are some key things to keep in mind:
- You can’t switch from cash to accrual overnight. It’s a process that takes time.
- Make sure you have reasonable bookkeeping procedures in place. Accrual basis accounting is much more complex than cash basis accounting, so it’s essential to have accurate records of revenue and expenses.
- Be prepared for some changes in how you track your finances. The accrual method requires different reporting methods and may require specialized software or spreadsheets.
Switching From Cash to Accrual
Changing cash to accrual accounting, you’ll need to do the following:
Add Accrued Expenses and Unearned Revenue Accounts The first step is to add two new accounts to your chart of accounts: accrued expenses and unearned revenue. Accrued expenses are the costs that have been incurred but haven’t yet been paid, while unearned income is revenue that has been earned but not received.
Add Accounts Receivable and Accounts Payable The second step is adding two new accounts to your chart of accounts called accounts receivable (money customers owe you) and accounts payable (money that you owe). It will give you a net figure for how much money your business owes or owes others.
Record Transactions in the New Accounts Once you’ve added the new accounts, you’ll need to record all of your transactions in them going forward. It includes cash receipts, cash payments, billings, and invoices.
Subtract Cash Payments from Accrued Expenses The third step is to subtract cash payments from accrued expenses. It will give you a figure for how much money you still owe for costs already incurred.
Add Prepaid Expenses and Subtract Unearned Revenue The fourth step is adding prepaid expenses and subtracting unearned revenue. Prepaid expenses are costs you have paid but not used, while unearned revenue is income that has already been received but not yet earned.
Subtract Cash Receipts from Accounts Receivable The fifth step is to subtract cash receipts from accounts receivable. It will give you a figure for how much money your customers have already paid you.
Next, Subtract Customer Prepayments from Accounts Payable The sixth step is to subtract customer prepayments from accounts payable. Customer prepayments are payments that have been received for services or products that haven’t yet been delivered. It will give you a net figure for how much money your business owes or is owed in current liabilities.
Calculate Net Profit/Loss The last step is to calculate your business’s net profit or loss. Next, subtract total expenses from total revenue. This will tell you whether your business is making a profit or losing money.
Changing cash to accrual accounting can seem daunting, but it can be a relatively simple process with the proper guidance. By adding new accounts and recording transactions in them, you’ll be able to get a clear picture of how your business is doing. And with that information, you’ll be able to make more informed decisions about the future of your business.
