One of the first accounting problems faced by first-time businessmen is the method of accounting to use– is it cash basis or accrual basis of accounting? Some seek help from accounting services Singapore firm because IRAS requires accrual basis for their business, nevertheless, small business have the choice to select either. For some whose problem is which one to use, this article will help you.
Cash basis of accounting treats income or expense as cash are received or paid. For example, if your electricity billing is $100 for the period January 1-30, but you didn’t pay it until the next month, which is February, when will you claim it as expense? The answer is February, the month you paid it. Another example: if your store performed a massage service in February, but your collection was delayed until March, your bookkeeping should include the income in March, the month of collection.
Accrual basis of accounting treats income as they are earned while expenses are recorded when incurred. Citing the previous example, you have an electricity bill worth $100 for the period Jan. 1-30, but you paid it in February, under accrual basis, when should you include it as expense? Answer is January. Next example, if your store performed a massage service in February, but the customer paid in March, under accrual basis of accounting, when will the income be recorded? Answer is February, the month the service was performed.
Before choosing, it is important to note that the two accounting methods have their own advantages and disadvantages. Biggest advantage of cash basis is its simplicity, yet it is also its advantage. Income and expenses are not recorded as they were earned or incurred.
Accrual accounting on the other hand, perfectly matches the recording of income and expenses to its appropriate accounting period. But, applying accrual basis will give rise to use of more accounts to account for the difference in timing of recording and collection/payment of cash. Accounts receivable, accounts payable, interest payable, utilities payable are some of the items that must be added to the chart of accounts. Let’s have another example.
Suppose your company sold an equipment in April, but the customer paid in May. The sale is worth $1,000. Assuming this is your only transaction, under cash basis of accounting, you will have no income in April but will have in May. Now, under accrual basis, how will you record it? What accounts should you use? Does this sound difficult? It shouldn’t. You don’t need to hire accounting services in Singapore in order to solve this. Here’s how: set-up an accounts receivable and at the same time an income account in April. Upon collection in May, you need to cancel out your accounts receivable then record the cash received.
As we can see in the examples, accrual basis is the better option because it has better timing in terms of recording income and expenses. Nevertheless, if your business hired bookkeeping services in Singapore to record a few transactions every month, better tell them to just use cash basis of accounting for your books.