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When are businesses required to use accrual accounting?

Modified on: 2018/07/17
A:

Accrual accounting involves stating revenues and expenses as they occur, not necessarily when cash is received or paid out. In contrast, cash accounting systems do not report any income or expenses until the cash actually changes hands. In general, most businesses use accrual accounting, while individuals and small businesses use the cash method. The IRS states that qualifying small business taxpayers can choose either method, but they must stick with the chosen method. The chosen method must also accurately reflect business operations.

Accrual accounting is based on the idea of matching revenues with expenses. In business, many times these occur simultaneously, but the cash transaction is not always completed immediately. Businesses with inventory are almost always required to use the accrual accounting method and are a great example to illustrate how it works. The business incurs the expense of stocking inventory and may also have sales for the month to match with the expense. If the business makes sales on credit, however, payment may not be received in the same accounting period. In fact, credit purchases are one of the many contributing factors that make business operations so complex. This is why the accrual method was adopted.

With global operations and the increasing intricacy of business, accrual accounting helps to show a precise, current picture of any business. If cash accounting is used, businesses, such as furniture stores, that sell on credit are often not able to report sales until all money is actually collected, when, in reality, the sale was made and is reasonably expected to be paid at a future date. It makes more sense for the business to accrue the sale and the cost of goods sold when the furniture leaves the store.


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