Which is better Cash Basis or Accrual?

Hi there, Linda Artesani, Artesani Bookkeeping. Today's post and accompanying blog are all about the differences between accrual-based accounting and cash basis. For the most part, I usually keep a client's records on accrual basis because I think it gives them a real-time vibe on how their business is doing. It's truly what accounting is. You see how much your sales are by counting the invoices, seeing how much you really earn because you're billing out. And then looking at the numbers at the year end, I will get the tax return from the client and see how their books are processed. And typically, for the most part, they're processed on a cash basis. And then I just change the reporting to cash basis so that we can give that to the accountant at tax time. At tax time, you usually select cash basis. I did for my own firm because I don't want to pay taxes on money that I've not I haven't earned yet. So if I bill a client on December 31st, 2019 for $1,000 and they pay me on January 15th, 2020, that $1,000, I'm not taxed on that $20— on that $1,000 until 2020 because that's when I received the money. That's when the payment was received. However, if you're doing accrual-based books, you're taxed on that $1,000 at the invoice time. So that's the difference between the invoices when you're looking at recognizing revenue with cash basis versus accrual. On the flip side, it's also the same with, with the expense side. So bills, if you're accrual-based, the date of the bill is the date that you recognize the expense. But if you are accrual-based— cash-based, you're going to recognize the expense at the time of the payment. So it's pretty simple and straightforward. However, and I'll show you on— I'm going to take you to QuickBooks and show you how that works. But also, The tax professional, if they're doing— if you're doing cash-based books, there's an entry that has to be made, or even in the accounting, you'll see when I change the— I flip the switch in QuickBooks, the revenue change happens. And if you don't— And there's usually a transaction that's going to happen to clear off the accounts receivable and accounts payable because it exists, but you have to get it off because it's not recognized. And then it's reversed in the next year so that you show your accounts receivable, accounts payable, because those people still— you still owe the bills and your customers still owe you. Let me take you to my screen and I'm going to show you the differences in QuickBooks and how QuickBooks handles it. So here we are in my law firm test file. And you can see that I've got a profit and loss up here. And I've got this set to cash. I'll show you how I save these for when I work with my clients. So here you can see that the— at the end of the day, it's $142,000 in profit for this firm for last year. Now if I switch it to accrual base, that's going to include all the invoices that were not paid. And if I switch it over to accrual base and then hit Run Report, I now have to pay taxes on $158,680. So there's a difference there when you look at The numbers. And if you were to put these side by side, you'd be able to see that maybe some of the legal services income's higher or whatever invoices are involved that were not paid. And you can actually see that if you run a report of unpaid invoices. Or open invoices. Who owes you open invoices? Now to the date of as of last year. And this is going to give you a guide to all the invoices that were not included that are going to total up to the difference between what I would have to pay in taxes if I'm accrual-based versus what I'm paying cash basis. Same thing if you run an unpaid bills report. One of the things that does pop up when you run a profit and loss on your records and you have I see this all the time on client files. It's one of my things that I have to clean up, and I will add a link into the post on this. We see unapplied cash payment income and unapplied cash bill payment expense or something like that. Those 2 terms are generally there because somebody will create an invoice, date it 12/1, but then they'll create a payment, which may be a prepayment. And obviously, if you're doing law firm accounting, you want to make sure that that Prepayment is a retainer and handled properly in the books. But for any other firm, they receive the payment. If they date the payment 11/30, but the invoice is dated 12/1, it causes this transaction because how can somebody pay an invoice before the invoice is created? So those are the kind of things that— and I do have another post in here that shows you how to fix that. But you need to fix the dates because the invoice can't predate the payment, or, or in that case, it's receiving a customer deposit. So that's the video for this week. It's kind of short, but short and sweet and to the point. And clearly, you choose what method you want when you are— when you first start your business. Most people do choose cash basis for obvious reasons. You don't want to pay taxes on money not earned. And that's when it gets involved with— if you are accrual, that's when you start to talk bad debt. If somebody doesn't pay you, you have to record bad debt, but you can't have bad debt. If you are cash basis, because you did not pay any taxes on the monies that aren't earned, so there's no bad debt. In that case, you just write a credit memo to remove that income off of your— move that invoice and write it down. So you would write a credit memo and use the same items to write it down if you're cash basis. If you're accrual, yes, you would do the bad— you'd make a bad debt item, write it down to bad debt, same thing, credit memo, write it down. And it's that simple to handle those kind of transactions. But I see it sometimes. I'll see bad debt or write-down or something on someone's books, and that you can't have that if you're cash basis. The other thing is with the transactions, the— usually the tax professional will give you a transaction to convert cash basis and then back to accrual by reversing the transaction. Those are good transactions to have if you had a lot of AR at the end of the year. And you need to write it off for tax purposes. So again, if you have any questions, comments— again, short video this week— but if you have any questions, comments, you know, need to reach out, please join our Facebook group. It's QB Community Live. I'd love to have you in the group. We answer questions all the time. And if it's not us as the admins, we, we will— other people answer. We have a great group of mastermind people. So it's a wonderful place to be. And if you need any help professionally, you need help on your books and you're a law firm, you want to reach out, feel free to reach out to me directly. I would love to help you do your books and take that headache off your shoulders, off your back, and make it— make your life a little bit easier by having somebody that knows this stuff take care of it. So thanks for watching. We'll see you next week. Bye now.