Welcome to the ‘Sam’s Story’ series, where we cover common accounting topics in a real-world scenario. This week we’re talking accrual vs cash accounting and what day-to-day bookkeeping options are available to a business.
Sam’s Story Recap
Sam’s Story Part One: Selecting a Business Entity for a New Business
Sam decided to open a new business, Sam’s Sports Bar, and turned to Gift CPAs to help him get on the right track and select the appropriate entity.
Cash Basis Accounting vs. Accrual Basis Accounting
Sam’s Sports Bar had its grand opening last week, but I wasn’t able to get there so last evening I stopped in for dinner. Sam is a client of mine so I figured I would see how business was going so far. Sam actually sat down and joined me for dinner and we got into an interesting conversation about cash basis versus accrual basis accounting. It all started with one simple question.
“How do I account for customers who run up a tab and pay for it the following month?” he asked.
I explained to Sam the difference between accrual and cash basis accounting. “If you were to use the accrual basis of accounting, you would record these transactions as income whenever your customer runs up the tab. If the customer runs up a $600 tab in June and doesn’t pay for it until July, you will be reporting the revenue and sales tax in June even though you didn’t receive the cash until July. If you were to use the cash basis of accounting you would not record the sales revenue until you receive the money in July. The same applies to paying your vendors. If you are using cash basis accounting you would record the expense when you pay the vendor. Using the accrual basis, you would record the expense when the goods are received. Does that make sense?”
“It does,” Sam replied. “Which way should I be keeping my books? Is there more of a benefit using one versus the other?”
“Well, cash basis accounting is a very simple way to keep track of revenues and expenses. It works well with small to medium sized businesses that are simple in nature. Your primary focus would be on the amount of cash in the bank and making sure bills are paid. The accrual basis of accounting is a more complex way to keep track of revenues and expenses, but is more accurate. Revenues and expenses are matched when they are earned, which gives you a more meaningful picture of how the business is performing. It would require a bit more work but if you’re up for it, I believe that is the way to go,” I answered.
After thinking about the options, Sam decided to use the accrual method. I came back a week later to assist him with setting up the system.
Day-to-Day Bookkeeping Options for a Business
One of the decisions that Sam had to make was how to keep the books for his new sports bar. He already had our CPA firm to prepare his tax returns and financial statements, but he was not sure how to handle the day-to-day bookkeeping chores such as tracking his income, his expenses, and payroll. There were a few different options Sam had to choose from, so he came to me with his questions.
Software program
Sam’s first option was to use a software program for his check writing and for tracking his income, expenses, accounts payable, and accounts receivable. I explained to him that using a software program would keep things neat and orderly, but with the line of business Sam was in, he would have to make sure that all his cash expenses were properly put into the software program, along with the checks that were written and the deposits that were made.
Paper tracking
The other option for Sam was to track all his income and expenses on paper each month.
Outsourcing
He also had the option of hiring someone to take care of this task for him, doing it himself, or outsourcing the task to our firm. Outsourcing is a great idea for a company, but with the type of business Sam was running, it would be difficult to keep everything on real time.
After we discussed the nuts and bolts details of how these options would work, Sam decided to purchase software to track his financial transactions. Sam was comfortable with handling it on his own at this point in time, but he knew that he always had the option to hire someone to handle it later if the need would arise.
Now that the bookkeeping had been decided, it was on to other issues.
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