Cash accounting records a transaction only when the money moves. Income is recognised when received and an expense when paid, with no entries for amounts owed but not yet settled.
What it means
Cash accounting is simpler than the accrual basis and tracks the bank position directly, which suits very small operations. Its weakness is timing: it can make a period look better or worse than it was, because it ignores money owed to or by the business. For this reason most businesses are required to use the accrual basis instead.
Where it fits in
Under pure cash accounting a pay run would only be recorded when net pay and the taxes are actually paid, which can straddle two periods. Accrual accounting avoids this by recognising the cost when the run happens, which is why payroll is usually accounted for on the accrual basis.
Key rules
- Recognises income and expense only when cash moves.
- Ignores amounts owed or prepaid.
- Simpler but can distort a period's results.
- Most businesses must use the accrual basis instead.
