Cash, accrual and cut-off
Cash accounting records when money moves. Accrual records when value moves. Every hard question in the rest of the course lives in the gap between the two.
- Reading
- 9 min
- Teaches
- 9
- Sources
- 4
Cash basis says: record it when the money moves. It is simple, it is what a bank statement gives you for free, and it cannot describe any business that gives or receives credit — which is every business with customers or suppliers on terms. It is also not GAAP.
Accrual basis says: record revenue when it is earned and expense when it is incurred, whatever the cash does. It is more work and it is the only basis that answers did we make money last month.
The idea underneath is usually called the matching principle: a cost is reported in the same period as the revenue it helped produce. That is why the goods Northwind sold on the 8th cost $5,200 in September even though $6,000 of the supplier's bill is still unpaid at month end. Strictly, the current Concepts Statements treat matching as a result rather than a rule — record every asset and liability correctly and the cost of a sale lands beside its revenue on its own. Costs that serve many periods, like the van, are not matched to particular sales at all: they are allocated over the periods they serve, $500 a month for 48 months rather than $24,000 on the day it was bought.
One caution, because it costs people money: this is a financial-reporting rule, not a tax rule. The IRS has its own definitions of the cash and accrual methods and its own rules about which one a business may use. A company can be required to file on one basis and report to its investors on another — those are two questions, and they are answered by two different books.
Cut-off is where the real errors are
Cut-off is the boundary question: does this belong to September or October? It sounds procedural and it is one of the most common sources of misstatement — auditors test it on every engagement — because the pressure is always in one direction: an invoice dated 1 October for goods delivered 29 September is September's revenue, and it will not feel like it to whoever is reading the invoice date.
Check yourself
Northwind delivers goods to a customer on 29 September and issues the invoice on 2 October. Which period earns the revenue?
Accrual accounting is entirely about the gap between when value moves and when cash moves. Every adjusting entry in the next lesson exists to close one of those gaps.
Where this lesson's rules come from
Requirements, conventions and mechanics are three different things. These are the sources behind the requirements — and the ones marked as conventions are ours, not the standard-setters'.
- CON 8, Introduction — as amended by Ch. 4, App. A (carrying forward CON 6, ¶139)What accrual accounting is forFree to read
- IRS Publication 538 (rev. 01/2022)Accounting Periods and Methods — cash and accrualFree to read
- ASC 606-10-05-3, -05-4; 606-10-25-23, -25-30Revenue from Contracts with Customers — the core principle, and recognition when control transfersFree after registration
- ASC 405LiabilitiesFree after registration
The full map is in US GAAP, and where these rules come from.
The words this lesson teaches
Each links to its definition in the glossary, where it also states the authority behind it and the components that render it.
- Accrual basisRecognizing revenue when earned and expense when incurred, regardless of when cash moves
- Cash basisRecognizing revenue and expense only when cash moves. Not GAAP for any entity — it is a special purpose framework (AICPA AU-C 800), and for tax a method IRS Pub. 538 and IRC §448 limit by entity type and gross receiptsConvention
- Matching principleRecognizing an expense in the same period as the revenue it helped produce
- CutoffRecording each transaction in the period in which it occurred — the boundary tested at every period endConvention
- PeriodA fiscal reporting window
- BasisCash or accrual
- Deferred revenueConsideration received, or unconditionally due, before the goods or services are transferred — a liability until the performance obligation is satisfied. ASC 606 calls it a contract liability
- Prepaid expenseCash paid before the benefit is consumed — an asset until it is
- Unbilled receivableRevenue recognized where the right to payment is unconditional but the invoice has not yet been issued — a receivable, not a contract asset
In the founder glossary
The ideas in this lesson, explained for the founder who runs the company. Each has its own entry in the founder glossary.
See also
- Periods & the closeThe month-end close in accounting software: fiscal calendars, period states, cutoff, reconciliation vs tie-out, adjusting entries and restatement.Doc
- Statement semanticsWhat each statement means, how it's structured, and what the components must therefore enforce.Doc
- CutoffWarningInline, with both legitimate remedies named.Component
- PeriodPickerFiscal-aware. Never assumes January.Component