How to Convert Accrual Basis to Cash Basis Accounting?

How to Convert Accrual Basis to Cash Basis Accounting

Converting accrual basis accounting to cash basis accounting involves adjusting for accounts receivable, accounts payable, and other accrued expenses or revenues that have been recorded under the accrual method. Here’s a basic approach on how to do it:

1. Accounts Receivable: Under the accrual method, revenue is recorded when it’s earned, not when the cash is received. So, when switching to cash basis, you would subtract the accounts receivable balance at the end of the period from your revenue. This is because these are revenues that have been recognized, but cash has not yet been received.
2. Accounts Payable: Under the accrual method, expenses are recorded when they’re incurred, not when the cash is paid. So, when switching to cash basis, you would subtract the accounts payable balance at the end of the period from your expenses. This is because these are expenses that have been recognized, but cash has not yet been paid.
3. Accrued Expenses: If there are expenses that have been accrued (recorded but not paid), these would also need to be subtracted from your expenses.
4. Prepaid Expenses: If you have expenses that you’ve paid in advance, these would be added back to your expenses under the cash method.
5. Unearned Revenue: If there is revenue that you have received in advance but not earned yet, this would be added back to your revenues under the cash method.

Remember, the cash method and accrual method are fundamentally different approaches to accounting, each with their own benefits and drawbacks. The accrual method provides a more accurate picture of a company’s overall financial health, while the cash method can be simpler and provide a clearer view of the cash coming in and out of a business.

Please note that this conversion can become quite complex depending on the complexity of a business’s transactions and financial condition. It’s always a good idea to consult with a professional accountant when making these types of changes to your accounting system.

Example of How to Convert Accrual Basis to Cash Basis Accounting

Let’s say we have a business called “BikeShop” that wants to convert its accounting from the accrual method to the cash method for the year ended 31st December 2023. Here are the key figures from BikeShop’s accrual-based income statement and balance sheet:

Accrual-based Income Statement for 2023:

• Sales Revenue: $500,000
• Cost of Goods Sold (COGS): $300,000
• Other Expenses: $100,000
• Net Income: $100,000 (Sales – COGS – Other Expenses)

Relevant figures from Balance Sheet on 31st December 2023:

• Accounts Receivable: $50,000
• Accounts Payable: $30,000
• Prepaid Rent: $10,000
• Unearned Service Revenue: $20,000

Here is how to convert these figures from the accrual basis to the cash basis:

1. Accounts Receivable: Under the accrual basis, the Sales Revenue includes $50,000 for which BikeShop has not yet received cash. So, we subtract this from the Sales Revenue. The adjusted Sales Revenue is $450,000 ($500,000 – $50,000).
2. Accounts Payable: Similarly, the expenses (COGS + Other Expenses) include $30,000 for which cash has not yet been paid out. So, we subtract this amount from the total expenses. The adjusted total expenses are $370,000 ($300,000 COGS + $100,000 Other Expenses – $30,000).
3. Prepaid Rent: The $10,000 prepaid rent was paid in cash during 2023 but wasn’t expensed under the accrual method. Under the cash basis, it’s considered an expense when paid, so we add this to the expenses. The adjusted total expenses become $380,000 ($370,000 + $10,000).
4. Unearned Service Revenue: The unearned revenue of $20,000 is cash received in 2023 for services not yet provided, so it wasn’t included in the Sales Revenue under the accrual method. Under the cash basis, we include it in the revenue when the cash is received, so we add this to the revenue. The adjusted Sales Revenue becomes $470,000 ($450,000 + $20,000).

Now, the cash-based income statement for 2023 would look like this:

• Sales Revenue: $470,000
• Cost of Goods Sold and Other Expenses: $380,000
• Net Income: $90,000 (Sales – Expenses)

So, by adjusting for accounts receivable, accounts payable, prepaid expenses, and unearned revenue, we have converted the accrual-based income statement to a cash-based income statement for BikeShop.