Cash to Accrual Basis Conversion Formats
Converting from a cash basis to accrual accounting is not overly difficult, but you should plan properly and understand both methods to ensure a smooth transition. While there is no single formula for moving from cash to accrual accounting, it's important to address all income and expense categories equally. Recognizing income as earned and expenses as incurred can dramatically change your company's profit and loss statement, particularly during the first year that you switch to accrual accounting.
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Income
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Cash basis accounting mandates that you record income only as it's received. For example, if you have sales of $10,000 in a month, but you only receive $2,000 in cash, then your business income for the month is only $2,000. When you switch to an accrual basis, your recorded sales for the month are $10,000, since you earned this amount. You still deposit $2,000, but record accounts receivable of $8,000. When you receive the remaining $8,000, you won't record new income. You will, however, record the cash received and lower the accounts receivable balance.
Operating Expenses
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The expense side of the business equation works identically. For example, say you incur expenses of $5,000 in a given month, but actually pay only $2,000 in that time. For cash basis accounting, your expenses for that month are $2,000, since that's what you actually paid. When you convert to accrual accounting, you record operating expenses of $5,000 and accounts payable of $3,000.
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Conversion Formats -- Income
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Determine what your accounts receivable would have been if you were using accrual accounting -- i.e., how much money is owed to you for prior and current period sales. Any monies still owed at conversion will form your starting accounts receivable amount. As these monies are collected, you won't record them as new sales, but as an influx of cash with an offsetting entry to reduce the accounts receivable balance. These accounts receivable become balance sheet assets, not expense accounts, since you've already recognized their cost.
Conversion Formats -- Expenses
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At conversion date, calculate all of the prior period operating expense balances you still owe. Set these balances up as accounts payable. For example, if you have utility bills with outstanding balances, record them as accounts payable, as a liability account on your balance sheet. When outstanding expense bills are due at coversion, you'll change the companies that are due payment into creditors, as if you had loans with them.
Timing Issues
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Depending on when you convert from cash to accrual accounting, you may need to make more adjustments to your books and records. For tax purposes, you'll need to "restate" your operating results for an entire year. You can avoid complex further requirements by taking the time to accurately record the total amount of revenue due you and expenses to be paid at the conversion date. Should monies be due, or remain to be paid, from prior years, you may need to amend your business's prior period income tax returns. The goal is to convert accurately, enjoying the benefits or dealing with the negatives of restating your operating results.
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References
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