There are two different accounting methods that get used to record accounting transactions:
- Cash-basis accounting
- Accrual accounting (more widely used and accepted by the Canada Revenue Agency)
The main difference between these two is to do with the timing of when you record your expenses and revenue. Accrual-based accounting means that you record any revenue or expenses when they’re earned or when they occur, no matter when you actually pay or receive the money. The accrual method requires the double-entry bookkeeping method we discussed earlier.
Cash-based accounting means that you only record your expenses or revenue once you actually receive the money or when you pay your suppliers, vendors, employees, etc. The same applies if you pay an expense on credit. To clarify, if you get a bill in August, but you only pay it in December, then under the accrual method, you’d report the expense when you get the bill (August). If you use the cash method, you’d only record the expense in December.
The method you choose is based on the size and complexity of your business, as well as whether you sell goods or services on account and if you make purchases on account. Cash-based accounting is much easier and it also allows you to look at your cash flow in “real time” by checking your bank balance rather than having to look at accounts payable and receivable. The accrual method, however, means you get a better, more accurate longer-term view of your business.
A lot of small businesses and sole proprietorships use cash-basis accounting, but accrual-basis accounting is the method the majority of businesses and professionals are legally required to use in Canada. According to the CRA, “Farmers, fishers, and self-employed commission agents can use the cash method or the accrual method to report income. All other self-employment income must be reported using the accrual method.”
Proper bookkeeping is a must to ensure you’re keeping track of your receipts and expenses so you can support your expense claims and your sales income.