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Differentiating accrual from cash-based accounting
In QuickBooks Pro 2008 Essential Training (www.lynda.com), instructor Suzanne Robertson explores the many powerful features of QuickBooks Pro, the popular accounting software that can be used for everything from handling personal expenditures to creating professional business account records. Suzanne covers organizing inventory and non-inventory items and using the automated EasyStep interview. She also demonstrates how to create and edit accounts, collect and pay sales tax, and handle invoices, vendor payments, and client refunds. Exercise files accompany the tutorial.
Note: QuickBooks Pro 2008 is not currently available for the Mac. If you are a Mac user you will be unable to open the exercise files for this tutorial, however you will still be able to watch the movies.
* Working with the Chart of Accounts feature
* Setting up items
* Tracking inventory items
* Using the Customer Center
* Invoicing customers
* Making client sales receipts
* Applying discounts and credits
* Entering and paying vendor bills
Like double entry accounting, accrual-based accounting is a standard accounting method.
Accrual-based accounting is the recognition of revenues and expenses based on receipt of products and services rather than payment. In accrual-based accounting you have not earned the revenue until the customer has received their product or service just as you have not incurred the expense until you have received the products or services you purchased.
The idea behind this principle is to prevent people from incorrectly stating their revenue by recording sales based on payment rather than the customers receipt of the physical product.
If you record revenue based on when a customer pays you, you're not following accrual-based accounting but rather cash-based accounting. Cash-based accounting is a method of accounting in which the payment of cash is the basis for revenue recognition. Cash-based accounting can distort the true income and expense of your business and can incorrectly reflect your income.
Click Play or press spacebar to start or stop video
Let's take a look at a cash-based sale to give you an idea of what I am talking about. In a given period you have sold many items but you have collected little to no money. However, you pay lots of bills. Under the cash-based accounting you're only recording revenue for items that you have been paid for so your income statement look something like this.
You have total income of $5,000. Your cost of goods sold is $1,300 leaving a gross profit of $3,700.
Your total expenses however were $3,900 which means you paid out more money than you were paid during the period. And that makes you suffer a net loss of $200.
Now, let's take a look at accrual-based to compare how different the scenario would be.
In accrual-based accounting in a given period you sell and deliver lots of products and services in addition to paying bills. And in this accounting method you recognize the income and expense at the time of delivery, so your income statement look something like this.
You've got total income of $11,500. Total cost of goods sold is only $1,900, and your gross profit is $9,600. Your total expenses are only $3900 so instead of a loss, we now have a profit of $5,700. So, you can see the difference between the two.
In accrual-based accounting I'm recognizing the revenue and expense at the time of receipt versus when someone has paid me. And this can drastically change how I report on my income statement.
Generally, the best method to use is accrual-based accounting as it will get the most accurate reporting of your finances. However, some businesses do report as cash-based for tax purposes. If you're unsure as to what method is right for your business you should consult with your CPA or accountant.
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As both an experienced artist and an accomplished professional in finance, Suzanne Robertson possesses a unique combination of creative and analytic talents. She utilizes her 20 years of business experience and 10 years of teaching experience, along with a distinct affinity for software, to teach complex subjects in a way that is both easy to understand and applicable to the real world.
Suzanne is happily married and lives in California, where she enjoys being a mother to two beautiful children. She works as a consultant, assisting small business owners in creating and maintaining successful financial practices.