when transactions are recorded on a cash basis they affect a company s books with a delay from when a transaction is consummated as a result cash accounting is often less accurate than accrual accounting in the short term 
most small businesses are permitted to choose between either the cash and accrual method of accounting but the irs requires businesses with over 25 million in annual gross receipts to use the accrual method 1 in addition the tax reform act of 1986 prohibits the cash accounting method from being used for c corporations tax shelters certain types of trusts and partnerships that have c corporation partners 2 note that companies must use the same accounting method for tax reporting as they do for their own internal bookkeeping example of cash accountingunder the cash accounting method say company a receives 10 000 from the sale of 10 computers sold to company b on november 2 and records the sale as having occurred on november 2 the fact that company b in fact placed the order for the computers back on october 5 is deemed irrelevant because it did not pay for them until they were physically delivered on november 2 under accrual accounting by contrast company a would have recorded the 10 000 sale on october 5 even though no cash had yet changed hands similarly under cash accounting companies record expenses when they actually pay them not when they incur them if company c hires company d for pest control on january 15 but does not pay the invoice for the service completed until february 15 the expense would not be recognized until february 15 under cash accounting under accrual accounting however the expense would be recorded in the books on january 15 when it was initiated limitations of cash accountinga main drawback of cash accounting is that it may not provide an accurate picture of the liabilities that have been incurred i e accrued but not yet paid for so that the business might appear to be better off than it really is on the other hand cash accounting also means that a business that has just completed a large job for which it is awaiting payment may appear to be less successful than it really is because it has expended the materials and labor for the job but not yet collected payment therefore cash accounting can both overstate or understate the condition of the business if collections or payments happen to be particularly high or low in one period versus another there are also some potentially negative tax consequences for businesses that adopt the cash accounting method in general businesses can only deduct expenses that are recognized within the current tax year 3 if a company incurs expenses in december 2019 but does not make payments against the expenses until january 2020 it would not be able to claim a deduction for the fiscal year ended 2019 which could significantly affect the business bottom line likewise a company that receives payment from a client in 2020 for services rendered in 2019 will only be allowed to include the revenue in its financial statements for 2020 