Legal Definitions - cash-basis accounting method

The cash-basis accounting method is an accounting approach where financial transactions are recorded only when cash actually changes hands. This means that income is recognized and recorded when it is received, regardless of when it was earned or invoiced. Similarly, expenses are recognized and recorded only when they are paid, regardless of when the goods or services were used or the bill was incurred. This method provides a straightforward view of a business's cash flow and is commonly used by small businesses, sole proprietors, and individuals due to its simplicity.

• Imagine Sarah, a freelance graphic designer. In March, she completes a website project for a client and sends an invoice for $2,000. However, the client doesn't pay her until April. Under the cash-basis method, Sarah would not record the $2,000 as income in March, even though she earned it then. Instead, she would record it as income in April, the month she actually received the cash payment. Similarly, if she purchased new design software in March but paid for it with her credit card in April, the expense would be recorded in April when the payment leaves her bank account.

  This example illustrates the cash-basis method because Sarah's income and expenses are tied directly to the physical movement of money into or out of her bank account, not when the work was completed or the bill was incurred.

• Consider David, who owns a small coffee shop. On a busy Saturday, customers purchase coffee and pastries, paying immediately with cash or card. David records all these sales as income on that Saturday because he received the money. Later that week, he receives a bill from his coffee bean supplier for a delivery made earlier in the month. He pays the bill the following week. Under the cash-basis method, the expense for the coffee beans is recorded in the week he makes the payment, not when the beans were delivered or the bill was received.

  Here, the coffee shop's financial records reflect income only when customer payments are collected and expenses only when supplier bills are settled, demonstrating the core principle of cash-basis accounting.

• Let's look at Maria, a self-employed consultant. In June, she provides advisory services to a client and sends an invoice for $5,000. She also receives her quarterly office rent bill for $1,500 in June, which is due by the end of the month. Maria's client pays her invoice in July, and Maria pays her rent bill in June. Under the cash-basis method, Maria would record the $1,500 rent expense in June because that's when she paid it. However, she would not record the $5,000 income from her client until July, when she actually receives the funds.

  This scenario highlights how the timing of cash receipt or disbursement dictates when transactions are recorded under the cash-basis method, rather than the date services were rendered or bills were issued.