What's the difference between cash and accrual accounting?

Define cash accounting by when cash moves and accrual by when revenue is earned and costs incurred. Give a December project paid in January, note that public companies must use accrual, and tie it to the cash flow statement.

The numbers, step by step

The insurance example from the answer: $1,200 paid on January 1 for twelve months of cover, on an accrual basis.

Expense each month$1,200 ÷ 12

$100

Expensed by March 31$100 × 3 months

$300

Still a prepaid asset$1,200 − $300

$900

What the interviewer listens for

• Do you define both by timing: when cash moves versus when it's earned or incurred?
• Do you give an example with numbers on the revenue side and the cost side?
• Do you know public companies must use accrual accounting?
• Do you connect accrual profit to the cash flow statement?

Common mistakes

• Saying accrual accounting ignores cash.Cash is still recorded when it moves, just not as revenue or expense at that moment.
• Recognizing revenue when a contract is signed.On an accrual basis it's earned when the company delivers what it promised.
• Telling the interviewer public companies can choose cash accounting.US GAAP and IFRS both require accrual.
• Stopping at the definitions without linking them to the cash flow statement, which reconciles accrual profit to cash.

Likely follow-ups

• Where do accruals sit on the balance sheet?In receivables, prepaid expenses, accrued expenses and deferred revenue. Each holds the gap between when something is earned or incurred and when the cash moves.
• Which basis tells you more about a business?Accrual for how it performed in the period, cash for whether it can pay its bills. I look at both, and a widening gap between net income and operating cash flow gets a question from me.
• The consultant's client never pays. What happens under accrual accounting?Under the allowance method the company has already booked an estimate of bad debts as an expense. Writing off this receivable uses up that allowance, so profit took the hit when the estimate was made.

More finance technicals

• What creates a deferred tax asset?
• How do you account for a 30% stake in another company?
• How do the three financial statements link together?
• Depreciation goes up by $10. Walk me through the three statements.
• A company raises $100 of debt to buy equipment. Walk me through the three statements at the time of purchase.

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