Choosing an Accounting method - The Accrual or the Cash method of accounting?

In accounting, there are two different accounting methods that can be used: The Accrual method and the Cash method of Accounting. They affect accounting in different ways and the way to work with them varies. Which accounting method you should use for your company is one of the most important questions when it comes to how your company should manage and operate its accounting. Which one you choose is entirely up to you, but if the company is large enough, you will have to choose the Accrual method of accounting.

In Finland the Government proposes that companies whose turnover during the financial year is a maximum of EUR 500,000 are given the opportunity to report VAT to be paid upon sales and VAT that is deducted for purchases in accordance to Cash Basis Accounting. This procedure would improve the liquidity of small businesses.

The Accrual method of accounting

The Accrual method is used in day-to-day accounting and means that customer invoices are posted when they are created and supplier invoices are posted when they are received. The payment is then posted separately when it is made. The Accrual method is mandatory for companies with a turnover larger than EUR 500,000 and is commonly used by limited companies.

The crucial difference from the other accounting method, Cash Basis Accounting, is that the Accrual method posts all invoices directly. The Accrual method is preferred in many cases by auditors as it is considered to give a more accurate picture of reality and facilitates accounting because an invoice can be linked directly to an accounting entry.

An incoming invoice (purchase) is posted as an expense in the Profit and Loss statement and as accounts payable in the Balance sheet. When the payment is made, it is posted and the accounts payable disappears. This means that the accounting takes place in two stages.

An outgoing invoice (sale) is posted as an income in the Profit and Loss statement and as accounts receivable in the Balance sheet. When the payment is received, it is posted and the accounts receivable disappears. This means that the accounting takes place in two stages.

Those using the Accrual method report VAT in their VAT return earlier than those using the Cash method. When you register your company for VAT reporting, you must state whether you want to use the Accrual method of accounting.

The Cash method of Accounting

This method means that the posting of income and expenses takes place when the cash is collected or disbursed, i.e. when a customer has paid a receivable or when a company has paid their accounts payable. The Cash method is often used by sole traders and other businesses with a net turnover of less than EUR 500,000 per year. Others who use this accounting method are companies that do not have as many transactions during a financial year and/or whose turnover does not amount to a larger sum. If net sales during the year will exceed EUR 500,000 (and will remain so), you are required to notify Vero of a transition to the Accrual method. This should be done before the next financial year.

The crucial difference from the Accrual method is that when using the Cash method, income and expenses are posted only when the money has actually been transferred. Using the Cash method is often considered a simpler version of day-to-day accounting because only incoming and outgoing payments are posted. This removes a part of the accounting because accounts receivable and accounts payable are left out.

However, at the end of the financial year all invoices that have not been paid yet must be posted on the last day of the financial year. Therefore, the Cash Basis Accounting method is sometimes called the year-end method.

When applying the Cash method, VAT must also be reported at the time of a payment in accordance with how invoices are posted. On the other hand, if there are unpaid invoices at the end of the financial year, the VAT on these must be reported in the financial statements. The year-end posting is always recorded using a type A journal and not in the subledger.

The Cash method of accounting in Briox

The Cash method in Briox allows the user to post their invoices so that they can continue to use both subledgers, the reminder functionality for customer invoices and the approval functionality on the supplier side. This is because the VAT is posted in a different way when choosing the Cash method:

• When the invoice is posted, VAT is placed in a settlement account that is not picked up by the VAT report.
• When the invoice is paid, the VAT is posted back to the VAT account so that it can be picked up by the VAT report.

At end of the financial year, however, all invoices that have not been paid yet must be posted on the last day of the financial year. 

When applying the Cash method, VAT must also be reported at the time of a payment in accordance with how the invoice are posted. On the other hand, if there are unpaid invoices at the end of the financial year, the VAT on these must be reported in the financial statements.

Choose accounting method in Briox

In Briox, you can choose which accounting method to use when you create a new financial year. Once the year is created, you do not need to think about how the accounting should be done as the program adapts to the method specified in the settings.