Cash vs Accrual Accounting: Meaning, Pros & Cons, and Tax Implications

How Cash Accounting Works

• Income is recognized when payment is received.
• Expenses are recognized when money is paid.

Example of Cash Accounting

• You sell goods worth ₹1,00,000 in January.
• The client pays you in March.

Income is recorded in March, not January.

Who Should Use Cash Accounting?

• Small businesses, freelancers, and professionals who want simple bookkeeping.
• Businesses with limited transactions.

How Accrual Accounting Works

• Income is recognized when the sale happens (invoice date)
• Expenses are recognized when liability is created (bill date).

Example of Accrual Accounting

• You sell goods worth ₹1,00,000 in January.
• The client pays you in March.

Income is recorded in January, not March.

Who Should Use Accrual Accounting?

• Medium and large businesses.
• Companies with inventory.
• Entities required by law to follow accrual system.

Corporate Entities (Mandatory Accrual Accounting)

• Companies and LLPs must use Accrual Accounting as per accounting standards.

Non-Corporate Entities (Option to Choose)

• Proprietorships, partnerships, and professionals can choose between cash or accrual.

Factors to Consider While Choosing

• Size of business
• Tax benefits
• Complexity of transactions
• Requirement of stakeholders (banks, investors, auditors, etc.)

Tax Under Cash Basis Accounting

• Income tax is paid only when actual money is received.
• Helps in managing cash flow better.

Tax Under Accrual Basis Accounting

• Income tax is payable when income is earned (even if not received).
• Can increase tax liability before cash is received.

Advantages of Cash Accounting

• Simple and easy to maintain.
• Suitable for small businesses.
• Tax is paid only when money is received.

Disadvantages of Cash Accounting

• Not suitable for large businesses.
• Does not reflect true financial position.
• Not acceptable under accounting standards for companies.