Accrual versus Cash Accounting Example

The following is an example of the financial events that transpire when a customer is billed and payment is received using accrual accounting.


Event	GL Accounting	Tax Payable Balance
Bill segment created	A/R 110 Revenue <100> Tax Payable <10>	(10)
Payment received	Cash 110 A/R <110>	(10)

In the above example, you'll notice that the payable is booked when the bill is created. Let's contrast this with what takes place if the payable is subject to payables cash accounting.


Event	GL Accounting	Tax Payable Balance	Tax Holding Balance
Bill segment created	A/R 110 Revenue <100> Tax Holding <10>	0	(10)
Payment received	Cash 110 A/R <110> Tax Holding 10 Tax Payable <10>	(10)	0

Notice that when the bill segment is produced, the liability is not booked, rather, the amount of the liability is placed in a "holding" GL account. When the customer pays, the moneys are transferred from the "holding" GL account to the true tax payable account.

Note:

Cash accounting is only applicable for liabilities. In the above example, you'll notice that only the tax payable account had cash accounting implications. This is because organizations that practice cash accounting only do it for liability accounts; they never do it for assets, revenue or expenses.

If the above seems simple, consider the following complications that must be considered:

What happens if a partial payment is received?
What happens if there are multiple taxes subject to cash accounting rules?
What happens if the A/R is relieved via a deposit seizure (or transference of a credit balance from another SA)?
What if, after payment, the original bill segment is cancel/rebilled resulting in a different amount of tax (keep in mind that the payable got booked when the payment was received)?
What happens if the payment is cancelled?
What if the payment isn't received and we have to write-off debt?
What happens if the customer overpays?
What happens if the customer is allowed to prepay their tax (this is a common practice in the United Kingdom) and then the tax rate changes at billing time?

The above points, and more, are discussed below.