- Cash accounting records income when money arrives and expenses when money leaves. Accrual accounting records income when it is earned and expenses when they are incurred.
- For income tax, Canadian businesses are generally required to use the accrual method. Corporations should assume accrual.
- Farming and fishing businesses may use the cash method for tax, and CRA allows it for some self-employed commission agents. Ask before you assume you qualify.
- Run your books on accrual and watch cash separately with a cash-flow forecast. You need both views.
Two businesses can do identical work in a month and show completely different profits, depending only on when they record the transactions. That is the whole difference between cash and accrual accounting, and it matters more than most owners expect.
This guide explains both methods, works through an example, sets out what CRA generally expects, and gives a practical recommendation for owner-managed businesses in Ontario.
Two ways to time the same transaction
- Cash basis accounting
- Cash basis accounting records revenue when payment is received and expenses when payment is made. The books follow the bank account.
- Accrual basis accounting
- Accrual basis accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands. Unpaid invoices become receivables, unpaid bills become payables, and costs paid in advance are spread over the periods they cover.
Neither method changes how much money you make over the long run. Both arrive at the same total once every invoice is paid and every bill settled. What changes is when profit shows up, and therefore what your monthly and annual results tell you.
Cash accounting answers the question “what happened in my bank account?” Accrual accounting answers “how did the business actually perform?” Those are different questions, and a growing business needs answers to both.
Accrual accounting relies on a few balance sheet accounts that cash accounting does without. Accounts receivable holds revenue earned but not yet collected. Accounts payable holds costs incurred but not yet paid. Prepaid expenses hold costs paid in advance, such as an annual insurance premium, until the months they cover. Accrued liabilities hold costs already incurred where no bill has arrived yet, such as wages earned at month-end. Keeping these accounts current is most of the extra work accrual requires.
A worked example
Here is an illustrative example with round numbers. A small contractor finishes a job in March and invoices the customer $30,000. The customer pays in April. In March the contractor also pays $12,000 for materials used on the job, receives a $4,000 subcontractor bill for the same job (paid in April), and pays $6,000 for a full year of insurance.
| Cash: March | Cash: April | Accrual: March | Accrual: April | |
|---|---|---|---|---|
| Revenue | $0 | $30,000 | $30,000 | $0 |
| Materials | $12,000 | $0 | $12,000 | $0 |
| Subcontractor | $0 | $4,000 | $4,000 | $0 |
| Insurance | $6,000 | $0 | $500 | $500 |
| Profit (loss) | ($18,000) | $26,000 | $13,500 | ($500) |
On a cash basis, March looks like a disaster and April looks excellent. On an accrual basis, March shows the job's real profit of $13,500 after its share of insurance, and April shows a small loss because no new work was done.
Over the two months, cash shows $8,000 of profit and accrual shows $13,000. The $5,000 gap is the ten months of insurance already paid but not yet used, which accrual carries as a prepaid asset on the balance sheet. Over the full year the totals match.
Cash accounting tells you when the money moved. Accrual accounting tells you which month earned it. Decisions about pricing, staffing and margins need the second view.
What CRA generally expects
For income tax purposes, the Income Tax Act generally requires business income to be calculated on an accrual basis. If your business is incorporated, assume your tax return will be prepared on accrual, whatever method the bookkeeping uses during the year.
There are recognized exceptions. Farming and fishing businesses may use the cash method for tax. CRA's guidance also allows self-employed commission agents to use the cash method in some circumstances. Each exception has conditions, and switching methods later has consequences. Talk to us about your situation before relying on one.
Two other timing rules catch cash-basis bookkeepers:
- HST. GST/HST is generally reportable in the period you invoice, or are paid if earlier, not only when the customer pays. A cash-basis ledger can understate the HST you owe for a period.
- Payroll. Source deductions are owed based on when employees are paid, and remittances follow CRA's schedule for your remitter type. Payroll liabilities need to sit on the balance sheet until they are remitted.
In practice this means even businesses that think in cash need someone tracking receivables, payables and tax liabilities on an accrual basis.
What lenders and financial statements expect
Accounting Standards for Private Enterprises (ASPE), the framework most Canadian private companies use, is an accrual framework. Lenders, sureties and investors will almost always expect statements prepared on an accrual basis.
Compiled statements under CSRS 4200 can be prepared on other bases, including a cash or modified cash basis, provided the basis is described in the statements. That flexibility is useful for very simple entities, such as some holding companies. For an operating business that borrows, bids or reports to anyone outside the company, accrual is the norm. Our guide to notice to reader and review engagements explains the different levels of statements.
Cash vs accrual, side by side
| Cash basis | Accrual basis | |
|---|---|---|
| Records revenue | When payment is received | When it is earned |
| Records expenses | When payment is made | When they are incurred |
| Simplicity | Simpler; follows the bank | Needs receivables, payables, accruals and prepaids |
| Matches revenue to costs | No; timing can split them across periods | Yes; costs land in the period they helped earn revenue |
| Shows cash on hand | Directly | Indirectly; needs a cash-flow view alongside |
| Income tax in Canada | Limited to specific cases such as farming and fishing | Generally required for business income |
| Lenders and investors | Rarely accepted for operating businesses | Expected |
| Best suited to | Very small, simple activities with no receivables or inventory | Most operating businesses, and every corporation that borrows or grows |
The practical answer: accrual books, cash in view
The useful question is not which method to pick, but how to see both pictures. Our recommendation for almost every owner-managed business:
- Keep the books on an accrual basis all year, not just at year-end.
- Close the books monthly so receivables, payables and accruals are current.
- Track cash separately with a short rolling cash-flow forecast.
- Read the profit and the cash position together. Profit tells you whether the work is worth doing. Cash tells you whether you can pay for it.
If your bookkeeping is currently on a cash basis and the accountant converts it at year-end, the switch is straightforward:
- Set a start dateChoose the first day of a month, ideally the start of a fiscal year, to begin accrual bookkeeping.
- Record opening balancesList unpaid customer invoices, unpaid supplier bills, prepaid costs and any accrued liabilities at that date.
- Change how documents are enteredEnter invoices and bills when issued or received, then record payments against them, instead of recording only the payment.
- Add accruals to the closeInclude accruals and prepaid adjustments in your month-end close so each month stands on its own.
Which one should your business use?
- Incorporated operating business: accrual, with a cash-flow forecast alongside.
- Business with receivables, inventory or job costing: accrual. Cash results will be misleading month to month.
- Business with a bank loan, bonding or investors: accrual. Your statement readers expect it.
- Very small sole proprietorship with no receivables: cash may be workable for internal tracking, but tax reporting is generally still on accrual.
- Farming, fishing or commission sales: the cash method may be available for tax. Get advice on your specific situation first.
Accrual books kept to a monthly standard are the core of our bookkeeping services, and our CPA partner prepares the year-end from them without rebuilding the ledger. If you are unsure which method your books use, or whether they are giving you the right picture, you can request a consultation.
Questions
What is the main difference between cash and accrual accounting?
Cash accounting records income and expenses when money moves. Accrual accounting records income when it is earned and expenses when they are incurred, using receivables, payables and prepaid accounts to bridge the timing. Over the long run both reach the same total; what differs is which period the profit falls in.
Can a corporation in Canada use cash accounting for tax?
Generally, no. Business income is required to be calculated on an accrual basis for income tax, with limited exceptions such as farming and fishing. A corporation can keep internal records however it likes, but the tax return will generally be prepared on accrual.
Is HST reported on a cash or accrual basis?
GST/HST is generally reportable in the period you invoice, or receive payment if that happens first, not only when the customer pays. That is one reason cash-basis bookkeeping can understate what you owe for a reporting period.
Is accrual accounting harder to maintain?
It adds receivables, payables, accruals and prepaid adjustments to the routine. Modern accounting software handles most of it once invoices and bills are entered when issued. The extra work is mostly in the month-end close.
Why does my profit look high when my bank balance is low?
Under accrual accounting, profit includes invoices customers have not yet paid and excludes costs paid in advance. Growth, slow collections and inventory build-up can all absorb cash while profit looks healthy. A cash-flow forecast read alongside the income statement shows where the money is.
This guide is general information for Ontario businesses, not advice for your situation. Rules change; talk to us before acting on it.