Let’s consider another example to illustrate the difference between cash and accrual accounting
In Month 1, a customer pays you 100,000 for a safari tour on the day they finish their tour. Your costs are 50,000 paid in cash.
Get 2 students to come up to draw the revenue, expenses, profit on the whiteboard
Set up the rows and columns (cash/accrual and revenue/expenses/profit)
In this case the impact under cash accounting and accrual accounting are the same. The reason being is because there was no delay between the delivery of the service or paying the expense and the receipt and disbursement of the cash. So when the cash is received on the day the service is delivered or if the cash is disbursed on the day the expense is incurred, the transactions under cash accounting and accrual accounting will not be any different.
In Month 2, you provide a tour package for 200,000. The customer agrees that they will pay you the next month. Your costs are 100,000 paid in cash.
Go through example – highlighting the difference in terms of profit
Under accrual accounting, even though we don’t receive the cash payment from the customer, if we look at the economic substance, there was a transaction. The company expects future cash flows so we would record the transaction
In Month 3, you receive 200,000 from the customer from the prior month. You also get a 200,000 deposit from a customer for a safari package to be provided in Month 4.
Go through example – highlighting the difference in terms of profit
How much cash did we receive in Month 4? 400,000 so we record revenue of 400,000 under cash accounting
Under accrual accounting, did we deliver any service in month 3? NO
The first 200,000 we received from the customer, the service was delivered in Month 2 and the revenue was recorded in Month 2
The 200,000 deposit we receive from the other customer, the service will be provided in Month 4 so no revenue in Month 3
The concept of Deferred Revenue we will explain in more detail later in the module
In Month 4, you deliver the service from the customer that paid you in the prior month. Your costs are 100,000 paid in cash.
Go through example – highlighting the difference in terms of profit
Under accrual accounting, you deliver the service from the customer that paid you a deposit in Month 3, so you must earn the revenue of 200,000
As the expenses were paid when they were incurred, the expenses under cash and accrual accounting are the same.
I don’t know if anyone noticed, but your cash balance under cash and accrual accounting are always the same. The cash the company receives doesn’t change based on the method of accounting. Cash is cash.
In Month 4, you deliver the service from the customer that paid you in the prior month. Your costs are 100,000 paid in cash.
Go through example – highlighting the difference in terms of profit
Under accrual accounting, you deliver the service from the customer that paid you a deposit in Month 3, so you must earn the revenue of 200,000
As the expenses were paid when they were incurred, the expenses under cash and accrual accounting are the same.
I don’t know if anyone noticed, but your cash balance under cash and accrual accounting are always the same. The cash the company receives doesn’t change based on the method of accounting. Cash is cash.