Cash versus Accrual Accounting

[John Morris]

Hi Mark,
  Thanks for your further thoughts.

> You are correct, the other side of the transaction is an income account. Since I don't use invoices, I am not that familiar with them. At a conceptual level, could you split the income account into two sub-accounts - income received and income pending? They would both roll up to the top level income account. All invoices go into income pending when posted, and when an invoice is paid, transfer the amount paid from income pending to income received. An extra step, I know, but perhaps it will spark another better idea. Perhaps that would work for A/P and expenses as well? You then pick which income and expense account you want in the income statement for cash or accrual basis? Lots of blue sky here, I know.

  Yes, one could do that, but all those extra transactions seem like unwanted extra work and open the door for more errors. At this point, with the further thinking about the issue from our conversation, I think my last idea is the way to go. Pulling a report of all transactions between the Receivables account and the two payment accounts we use (Checking for payments by EFT and paper check and PayPal for payments by credit card and PayPal direct transfer) should not be difficult and it will show exactly when we received the income without requiring any extra transactions to artificially move recorded transactions.

  The only problem with this idea is that we would not be easily able to distinguish different types of income. Fortunately, we have just one type of income, so this disadvantage does not matter to us. I think if I did need to distinguish types of income (such as income from in-state and out-of-state sales or income from labor or materials), then I think I would set up different subaccounts of the main Receivables account and post invoices appropriately.

> As far as converting from accrual to cash basis, any good accounting or finance text book can tell you how to do that. My finance professor in business school loved assigning those types of problems to the second years! Here is the first link from a google search - http://www.accountingtools.com/questions-and-answers/how-to-convert-accrual-basis-to-cash-basis-accounting.html.

  Now I see that we were talking at cross purposes. You were talking about the theory of how accrual accounting is, in general, converted to cash accounting. I was talking about the specifics of how it would be most easily done in in GnuCash given it's particular strengths, weaknesses and oddities. I do understand the theory of accrual versus cash accounting: Although I never studied it in school, I have done enough business and tax accounting to have picked up what I need to know. However, because I have not used GnuCash for long, I have not yet discovered all of its hidden strengths and features.

> I would really recommend using separate Gnucash files for personal and business...it just makes life easier, and since the IRS expects separate bank accounts for personal and business accounts, I think separate books is a good idea.

  Yes, I've heard that argument before. However, I don't subscribe to it. I feel that it is much more important for me to do what works best for me in my day-to-day work. The government is in place to serve the people. Therefore, the IRS can expect all it wants, but it takes what it gets in the end. While we do keep our business money in a separate bank account from our personal money, that is because that system works best for us, not because the IRS would like it so. The same goes for our separate sets of books. As I said before, if I were doing all the books myself, I would keep a single set with appropriate safeguards to reduce the chance of error. That would allow me to make transfers between business and personal accounts as needed without requiring the extra work of two separate accounts.

Best,
John