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Comparing accrual and cash accounting

Comparing Accrual and Cash Accounting. Created by Sal Khan.

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  • leafers sapling style avatar for user sanrin24
    What happens, for example, if you are providing meals over a four-month period and you receive 1/2 the money at the beginning and 1/2 the money at the end?
    (10 votes)
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    • leaf green style avatar for user Pureum Kim
      In accrual accounting, it would be done as following. Suppose that you sign a contract in 1/1/11 that pays you $400 for providing meals over a four month. You receive $200 when you sign the contract and receive the remainder $200.

      1/1/11
      Debit cash 200
      Credit deferred revenue 200
      *This is because you have not provided the service yet but you have received money.

      2/1/11
      Debit Deferred Revenue 100
      Credit Revenue 100

      You have provided the first month of service. So now you can convert deferred revenue to revenue because you completed your service.

      3/1/11

      Debit Deferred Revenue 100
      Credit Revenue 100

      You have provided the Second month of service. So now you can convert deferred revenue to revenue because you completed your service. Now you have zero deferred revenue.

      4/1/11
      Debit Accounts Receivable 100
      Credit Revenue 100

      Now you have provided the meals but did not receive the money. So you debit accounts receivables and credit cash.

      5/1/11
      Debit Accounts Receivable 100
      Credit Revenue 100

      You have provided the meals but did not receive the money. So you debit accounts receivables and credit cash. Also, you will get paid the other 1/2, 200. So you have to


      Debit Cash 200
      Credit Accounts Receivable 200


      In the end, if you add up all the debits and credits. You will have

      Debit Cash 400
      Credit Revenue 400

      Hope this is helpful :)


      (52 votes)
  • old spice man green style avatar for user Raymond.AN
    what is the difference between the concepts of "accrual" and "deferred"? I got confused about the two. Another question is which of those means "prepaid",and which of those means "delayed"?
    (1 vote)
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    • leaf green style avatar for user Abhishek Kulkarni
      Accrual is a type of accounting wherein the entries are recorded when the transaction actually takes place usually on the invoice date and the money is not paid yet.
      Deferred is referred to the payment that is paid in advance and no service is rendered against the payment. After you provide the service, the deferred payment will be transferred to cash.
      (8 votes)
  • male robot johnny style avatar for user Andrey Moroz
    Is Deferred Revenue the same as Accounts Payable? If not, what is the difference between them?
    (2 votes)
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  • blobby green style avatar for user sherriocane
    If I went to a flower shop to purchase a dozen roses. I didn't use cash, but used a credit card for the purchase.
    Would this example of Accrual Accounting or of Cash-basis accounting?
    (2 votes)
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  • blobby green style avatar for user Pranavi
    Following this example, since there is $200 marked down as Deferred Revenue, would that amount be shown on the income statement for Month 3 or would you have to wait until you actually do the service the next month? (in accrual basis)
    (2 votes)
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  • blobby green style avatar for user chadandsal
    Should the "Cash" amount in month 3 (accrual basis) not be $300 since the $200 was being deferred to month 4? I'm trying to follow and the $100 profit in month 4 added to the cash of month 3 then should equal $600??
    (2 votes)
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    • leaf green style avatar for user Brandon S-p
      No, the Cash amount is correct because if you take a look at the original problem, you were paid the $200 in advance. The deferral is in reference to when you actually earn the income(perform the service) vs simply being paid. Yes you were paid in advance, but you have not yet performed the services for which you were paid :)

      You had -$100 in cash from month 2, but were owed $400 (Recognized under accounts receivable). That along with the advanced $200 payment = $500 Cash at the end of the 3rd month!

      The $100 profit in month 4 is written in recognition for actually catering the event that you had been paid in advance for. It is recorded in the accrual basis to help see and recognize what was going on in the month! You don't actually add that to your cash balance since it was already accounted for (received) in the previous month. (Unfortunately your profit and cash balance aren't always the same like the first month)

      Your cash balance was at $500 from month 3, but the catering event in month 4 racks up $100 in expenses, leaving with you $400 at the end of month 4.

      - To recap, remember that you were paid $200 in month 3 to cater an event the following month, that amount was recognized as cash as well as deferred income since you had not catered yet. In month 4, you take that $200 of deferred income and properly record it as your revenue for the month, alongside $100 of expenses. That leaves $100 of profit for the month, but since you did not receive any other income in the form of cash during that month, $100 of expenses is still subtracted from the cash balance.



      Hopefully that helps!
      (3 votes)
  • mr pink red style avatar for user Christi M
    How do credit card charges show up in cash vs accrual accounting? Should charges be dated when they were charged OR when the credit card was paid? It sure would be great to see how credit card charges affect the above. Also, similarly, when checks are written OR when they are cashed by the recipient? Often times, when things are charged and when they are actually paid/cashed fall into separate months. Let's keep this to a simple small business scenario if possible.
    (4 votes)
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    • old spice man green style avatar for user Molly Collier
      This is a great question! Credit cards are stored as credit, meaning yes it is stored under accounts receivable. I also would like someone to answer when it gets moved to the cash account. I assume that it is when the credit card company like American Express sends the payment to the organization it will be moved to cash, but I have not been taught what truly happens.
      (1 vote)
  • blobby green style avatar for user ronicelbarlow
    why does cash go down in the last month by $100 (from $500 to $400) when the profit was $100?
    (2 votes)
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  • primosaur tree style avatar for user Nico Fermanelli
    Why would anyone use cash accounting?
    (2 votes)
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  • leaf green style avatar for user Travis
    Does double-entry accounting have anything to do with either of these two methods?
    (1 vote)
    Default Khan Academy avatar avatar for user

Video transcript

So one of the main purposes of accounting for anything, of making these accounting statements in the first place, is so that you can reflect what's going on in the business. And that might be for investors, to see how business is doing, or it might be for the managers of a business, so that they can see where the business is doing well, or where it's not doing well, or maybe how resources should be allocated. So let's see which of these two methods of accounting, the cash method or the accrual method, give a better indication of what's actually going on in the business. And the way I did it in the first two videos, for each month, this first column right over here, this is the cash basis of accounting. And this right here is the accrual. So the second column is the accrual. Let's just look at the income statement. We're assuming a very simple world where there's no taxes. We have no debt. We have no interest, things like that. We just literally have revenue, some expenses associated with that revenue, and just a simple profit. We'll make it more complicated in the future. So this right here, you could view as our income statement. This is our income statement for month one on a cash basis. This is our income statement on month one on an accrual basis. Now when you look at the cash basis in month one, and when you look at either basis on month one, it gives you the same thing. So that's not so interesting. Let's go to month two. In the cash basis of accounting, it looks like you just lost $200. To an outsider who didn't know the details of what's actually going on in the business, they think something shady is going on, or it's a money losing business. Why would I want to invest in this? They're losing $200 a month, just looking at this month alone. But when you look at the accrual basis, it better reflects that look, you actually did some catering. In fact, you did a pretty large catering event that month. In fact, that's why you had so many expenses. And if you recognize the revenue for the service that you actually did that month, that $400, which we did in the accrual basis, then you could actually say, look, I performed services that will earn me $200, assuming that the customer is going to be good for their money. And instead of putting that $400 in cash, because you didn't get the cash, you can't do that. We said, look, the customer owes us $400. But that's still an asset. An asset is anything that someone owes you, some future benefit. So the customer is going to give you cash in the future. Cash is an asset because you can use that to go buy stuff, to get other people to do stuff for you, to get some future benefit. So both cash and accounts receivables are assets. And so in month two, I think it's fair that accrual method is giving us a better indication of what actually happened. Let's go to month three. On the cash basis, when you look at the example, you actually did nothing in month three. You could have gone on a vacation in month three. There was no actual catering done. But on the cash basis, it looks like this was your best month of catering ever, because you actually get $600 inflow in cash, and you didn't have to spend any expenses, because you didn't do any accounting. But when you do the accrual basis, it actually reflected what happened. You had no revenue and no expenses associated with that revenue. So once again, to an outsider, they'd say, hey month three, maybe you took a break, maybe you took a vacation, or that was just a slow time in your business. And you don't recognize the revenue from this $200 in advance, because you didn't do anything to get it. Instead, you said, look, I got this $200, it's a cash advance, you could've even called this a cash advance from customers, but I'm not recognizing this in revenue in the month that I got it. I'm waiting until I actually perform the service. So I'm deferring the revenue. And so you defer it to month four when you actually perform the service. The $100 in expenses are associated with that $200. And so it makes sense to you had $100 in profit. Once again, in month four, you did work, you should have profit. On a cash basis, it looks like you lost money again. So hopefully this gives you a little bit of an idea of why accrual gives a better picture of what's happening in the business. In the next video, I'll try to reconcile what the accrual income statement is telling us and the actual cash, because right now it might look a little mysterious.