Accrual accounting provides an accurate way of matching business income and expenses to the correct time periods, explains Nolo. Businesses with sales of over $5 million per year or inventories exceeding $1 million are legally required to use accrual accounting.
Accrual accounting is required when preparing financial statements that are expected to conform to generally accepted accounting principles, according to Accounting Coach. This consistency also eases tax calculations. However, determining the date of a purchase or sale can be problematic, according to Nolo. To solve the problem, sales should only be recorded after all goods are delivered or when a service such as installation is complete.
That is not the only disadvantage of accrual accounting, according to Accounting Coach. Because the accounting method records income at the time of sale even when no money is received, income ledgers may show cash on hand that, in reality, is yet to be realized. That may make it more difficult for businesses to manage cash flow.
The other method of recording business incomes and expenses is known as cash accounting, according to Nolo Under this method, incomes are recorded when cash is actually received, which may not coincide with the period when a sale is made. The same rationale is used when recording expenses. While a better method for keeping track of cash flow, cash accounting can make it difficult to calculate taxes and to match expenses and incomes to the right periods of time.