Cash basis accounting says the sale is recorded on the income statement the day you receive the money. Well let’s say that you sell $1,000 of medical supplies on June 25^th 2007. Did you collect the money on that day or did you give the customer 30 to 60 days of credit? You may have made the sale in June, although it could be July or August when you collect the money and that is when the income is recorded according to GAAP (Generally Accepted Accounting Principals).

Using cash basis accounting the cost of goods sold is recorded on the day you write the check. So what does this all mean? Well let’s say that you have a medical supply company and you go out and buy a case of band aids, 5 wheel chairs, and 10 oxygen tanks on May 30, 2007. Did the vendor give you credit and allow you to pay in 30 to 60 days or did you write a check on the spot? When you actually write the check is when you record the cost of goods sold.

So how much did you make this month? With cash basis accounting you don’t know because your income from sales probably does not match your cost of goods sold in the same month. So why use cash basis accounting at all. Because it is simple and easy to understand. Receive the money and that is income. Write a check and pay a bill is an expense. No asset and liability accounts to really worry about.

Accrual basis accounting says the sale is recorded on the date you ship the product. It does not matter when or if you receive payment the income is recorded on the shipment date. The date you ship the product you will also reduce your inventory balance sheet asset value by the amount of the product cost and you will record the same amount to the costs of goods sold account on your income and expense statement.

When running accrual basis accounting you have much better idea of how much you made or lost in any given period. Comparisons of this year versus last year sales and expenses are much more consistent. In general most companies use accrual based accounting for this reason.

BH