What is Accrual vs cash accounting?

Cash accounting is the simpler method: a sale counts when the customer pays, and an expense counts when you pay the bill. Accrual accounting records a sale when it is earned (usually when goods ship or the invoice is issued) and an expense when it is incurred, regardless of when cash moves. Accrual books therefore carry accounts receivable, accounts payable, prepaid expenses and accrued liabilities, which cash books do not.

In Canada, most businesses must use the accrual method to calculate business income for tax. The CRA allows cash-basis reporting only in narrow cases, mainly farming, fishing and some self-employed commission income. Incorporated businesses filing a T2 return use accrual figures, and financial statements prepared for lenders or under accounting standards are accrual-based. GST/HST is also generally reported on an accrual basis, when tax becomes collectible, though some small businesses can elect quick or simplified methods.

Accrual accounting gives the more honest picture of performance. If you deliver a $20,000 job in March and get paid in May, accrual books show the profit in March, when the work was done. Cash books would make March look poor and May look excellent. Most owners still watch cash closely, which is why a good accounting system keeps accrual books and also produces a cash flow statement and projections.