How to Convert Cash Basis to Accrual Basis Accounting
Converting from cash basis to accrual basis accounting involves adjusting for accounts receivable, accounts payable, and other items. Here’s how you might do this:
- Accounts Receivable: On a cash basis, revenue is recorded when cash is received, not when it’s earned. So, when switching to accrual basis, you would add any amounts that are owed to you at the end of the period (but for which you have not received cash) to your revenues.
- Accounts Payable: On a cash basis, expenses are recorded when cash is paid, not when they are incurred. So, when switching to accrual basis, you would add any amounts that you owe at the end of the period (but have not yet paid) to your expenses.
- Prepaid Expenses: If you have expenses that you’ve paid in advance, these would be subtracted from your expenses under the accrual method because they are not yet incurred.
- Unearned Revenue: If you have cash that you received in advance for services or products you have not yet provided, these amounts would be subtracted from your revenue under the accrual method because the revenue is not yet earned.
Remember, moving from cash basis to accrual basis can become complex depending on the specifics of a company’s financial situation. Consulting with an accounting professional is always a good idea when making these kinds of changes.
Example of How to Convert Cash Basis to Accrual Basis Accounting
Let’s assume we have a small business called “Local Landscaping” that operates on a cash basis and wants to convert its accounting to accrual basis for the year ending December 31, 2023. Here are the key figures from its cash basis income statement and some additional relevant information:
Cash basis Income Statement for 2023:
- Revenue: $100,000
- Expenses: $70,000
- Net Income: $30,000 (Revenue – Expenses)
Additional information:
- Accounts Receivable (services provided but not yet paid for by clients): $10,000
- Accounts Payable (expenses incurred but not yet paid): $5,000
- Prepaid Insurance: $2,000
- Unearned Revenue (payment received for services to be provided in 2024): $3,000
Here is how to convert these figures from the cash basis to the accrual basis:
- Accounts Receivable: The cash basis revenue does not include $10,000 for services provided in 2023 but not yet paid for by clients. So, we add this to the revenue. The adjusted revenue is $110,000 ($100,000 + $10,000).
- Accounts Payable: The cash basis expenses do not include $5,000 for services that were received in 2023 but not yet paid for. So, we add this to the expenses. The adjusted expenses are $75,000 ($70,000 + $5,000).
- Prepaid Insurance: The cash basis expenses include $2,000 for insurance that was paid in 2023 but is for coverage in 2024. So, we subtract this from the expenses. The adjusted expenses are $73,000 ($75,000 – $2,000).
- Unearned Revenue: The cash basis revenue includes $3,000 for services that were paid for in 2023 but will not be provided until 2024. So, we subtract this from the revenue. The adjusted revenue is $107,000 ($110,000 – $3,000).
Now, the accrual-based income statement for 2023 would look like this:
- Revenue: $107,000
- Expenses: $73,000
- Net Income: $34,000 (Revenue – Expenses)
So, by adjusting for accounts receivable, accounts payable, prepaid expenses, and unearned revenue, we have converted the cash-based income statement to an accrual-based income statement for Local Landscaping.
