Understanding Accounting Methods
An accounting method refers to a set of rules and guidelines established by a governing body that dictates how an organization records its business transactions in its books of accounts.
The two primary methods available to organizations are the cash and accrual methods.
Single-Entry Accounting/Cash-Based Accounting
Cash-based accounting only records revenue and expenses when actual cash is received or paid. Many businesses favor this method for its simplicity and ability to reflect real cash flow.
However, it may not play a significant role in long-term decision-making processes.
Cash accounting can be advantageous for certain types of businesses regarding tax payments since it allows for control over the timing of transactions based on actual money transfers.
Double-Entry Accounting/Accrual Accounting
The accrual method records revenue and expense transactions when accrued or incurred.
This method follows the principles of accounting commonly adopted by larger organizations.
It involves more complex accounts, such as accounts payable, long-term liabilities, current assets, and inventory.
Under this method, revenue is recognized when a transaction occurs, regardless of whether the cash has been received, while expenses are recorded when bills are received.
Choosing an Accounting Method
When selecting an accounting method, consider the following factors:
- Size of Your Organization: The bookkeeping requirements of a small business differ significantly from those of a large corporation. Choose an accounting method that suits the needs of your company.
- Future Plans: To expand your business, consider selecting an accounting approach based on future growth rather than current size. Hiring personnel may also influence your decision.
- The Organization’s Legal Framework: Certain legal requirements may mandate accrual accounting. Large companies, C corporations, and publicly traded firms often use accrual accounting.
Modified Cash-Basis Accounting/Hybrid Accounting Method
The hybrid accounting method, also known as modified cash-basis accounting, combines elements of both accrual-based and cash-based accounting.
It offers a middle ground for business owners who desire aspects of both cash and accrual accounting.
This approach may provide a more realistic financial picture, especially when other methods have certain limitations.