Accrual accounting and cash basis accounting are the two most common accounting methods used by U.S. companies. Accrual accounting records transactions as they occur, while cash basis accounting records transactions only when cash changes hands. Hybrid accounting methods usually combine aspects from both accrual and cash basis accounting, according to company operations.
IRS Accounting Rules
According to the Internal Revenue Service (IRS), companies must match revenues and expenses under their preferred accounting method. For example, if revenues are recorded using the cash basis method, expenses must be recorded under the same method; this matching principle also relates to recording revenues and expenses under the accrual method. Companies that hold and sell inventory are required to use the accrual accounting method.
Hybrid Accounting in Practice
Under a hybrid accounting method, companies will use the accrual accounting method to satisfy tax requirements and the cash basis method for all other financial transactions. Accounts receivable and accounts payable are the only items recorded using the accrual method; A/P transactions relate to inventory, as required by the IRS. Financial transactions like asset purchases, payroll or equity investments are recorded using the cash method, reflecting transactions where cash changes hands.
Hybrid Accounting Benefits
Hybrid accounting benefits companies by allowing them to record sales transactions as they occur, which makes trending or forecasting estimates for future accounting periods more accurate. Using the cash basis method for other transactions allows companies to closely monitor their cash on hand, assuring managers that sufficient cash reserves are available for daily operations. The cash basis method is also an easier method for recording financial transactions, allowing small business managers to record financial transactions without hiring an accountant.
Choosing an Accounting Method
When choosing an accounting method, companies should always consult an accounting firm to ensure that their method is acceptable and meets all IRS requirements. Once an accounting method is selected and filed with the IRS, it is very difficult to change the accounting method for tax purposes.