The accrual principle vs the cash principle
The general accounting plan serves as a normative basis to quantify and record the accounting facts or events that a company generates. Within this regulation, one of the fundamental principles of current accounting is included, the accrual principle. The accrual principle could be defined as opposed to another concept known in the accounting world, such as the cash principle. In this article, we will proceed to explain in detail the first of them, the accrual principle, along with its implications and its main distinction compared to the other principle mentioned.
If you want to know in detail what the accrual principle is and how it differs from the cash principle, this article is for you.
The accrual principle
The accrual principle is an accounting principle by which an accounting fact or event is required to be recorded in the company’s accounting at the time it occurs, regardless of when the payment or collection is made. The accrual principle applies to all accounting events of a company, from income and payments, to debt interest, through VAT returns, in short, all events follow this criterion when being recorded for accounting purposes.
The final purpose of this criterion is for the company to faithfully record accounting events at the time they occur, so that it will have a main impact on the annual and accounting accounts of the companies.
The accrual principle vs the cash principle
Just as the accrual principle tries to record accounting events at the time they occur, the cash principle refers to the opposite criterion. In other words, according to the cash criterion, events are recorded based on the moment in which there are cash or money inflows or outflows, that is, when payments or receipts derived from a transaction are made. As we said previously, with certain exceptions, the general accounting standard is governed by the accrual principle, and the cash criterion is only used in the field of treasury and the modeling of financial projections in which the generation of cash flow is the main metric analysed.
Accounting example of the accrual principle
In order to provide a better understanding of the accrual principle, we proceed to explain it with an example below.
Let’s imagine that company A achieves merchandise sales of 10,000 euros in January and issues an invoice to customer XY for an amount of 10,000 euros to be paid in 60 days. Client XY therefore, after 60 days or two months, that is, at the end of March, proceeds to pay the invoice of 10,000 euros.
How would this transaction be recorded in company A’s accounting? In accordance with the accrual principle that we deal with in this article, company A will record 10,000 euros of income in January, despite the fact that it has received the invoice in March. As we have explained at all times, accounting requires recording sales revenue in the company’s accounting at the time it occurs, so in this case the accounting event would be recorded in January.
The accrual principle and accounting regulations
As we said initially, the accrual principle is the main principle that prevails in current accounting since it is regulated in such a way by the general accounting plan
However, the general accounting plan includes certain exceptions when certain requirements are met, especially focused on prioritizing or protecting small and medium-sized enterprises (SMEs).
Benefits and drawbacks of the accrual principle in accounting
The main benefit of recording the events when the accounting event occurs and not when the payment is made, is that it allows generating a true accounting image of the companies. Let us imagine, for example, the case that we described previously. Let’s imagine that company A sells 10,000 euros in January, 10,000 euros in February, and 10,000 euros in March. And for any liquidity reason of client XY, the client decides to pay the 3 invoices issued in April. We would therefore have 3 different accounting facts, sales in January, February and March, and a large collection in April. If we recorded 30,000 euros of sales in April, the company’s image would be completely distorted and far from reality. That is why the accrual principle prevails in accounting today.
And then, what is the problem of the accrual principle? The main problem of the accrual principle, and that mainly affects small companies, and mainly affects the declarations and the payment of VAT. The problem would be the following. Let’s go back to the case of the previous example of company A. Let’s imagine again, that company A sells 10,000 euros worth of merchandise in January. And for some reason unknown to us, customer XY has to delay paying the invoice until June. In this case, according to the accrual principle, the VAT derived from the sale of merchandise in January is also accrued at the time the sales take place. In other words, as the company has sold merchandise and a corresponding VAT is generated, company A has the obligation to pay the VAT charged for that transaction in the quarter in which the sale occurs. As customer XY has not paid until June. This would mean a serious cash problem for company A, which is forced to pay VAT for which the invoice has not yet been received.
Faced with this problem, and which can have a very large impact on the cash and treasury situation of small companies mainly, the general accounting plan admits some cases or exceptions for which SMEs can benefit from the cash principle.
Next, we collect the requirements to benefit from the cash criterion.
Requirements to benefit from the cash criterion
– Not to exceed 2 million euros of annual turnover
– Do not exceed 100 thousand euros in annual charges to the same client
– That it does not produce in intra-community operations (between member countries of the European Union)
– That it does not occur in operations under a special VAT regime such as module regimes, or special agricultural ones, for example.
Snab as a treasury management tool that allows cash to be managed more efficiently
Snab is a pioneer cloud treasury platform in Europe that supports finance and treasury teams in any and all functions and tasks related to treasury management and monitoring of the company’s cash position. Snab is therefore a tool that, as it deals with treasury, touches an area closer to the cash principle explained above. Therefore, the invoices paid or collected in Snab are monitored based on the cash principle, but they will be recorded in accounting at the moment in which the accounting events occur. Snab helps finance teams, therefore, by enabling greater visibility and control of treasury. Snab serves as a banking aggregation platform, allowing companies to access all their bank accounts in different banks and in different countries from a single place and with absolute independence, so that the financial team can access their situation in a few clicks of cash and thus obtain the necessary information to calculate the available and realizable assets of the company. Snab also serves as a billing tool, that is, it automates the entire invoice receipt, scanning, and automatic recording process, and also serves as a payment and collection management tool, providing full control and visibility to the functions of accounts payable and receivable. The platform has pioneering technology in Europe that allows you to pay and collect invoices in one click, from Snab, without having to leave the platform. Digitize your business with Snab.