Cash and accrual accounting are two widely recognized approaches to managing your company's financial records. Understanding the distinction between these methods is crucial because they handle gift cards and internal account balances in contrasting ways. In this article, we'll explain the differences between these two methodologies and clarify why we opt for accrual-based accounting for our Purchases report.
Consider this scenario:
On August 1st, a customer purchases a £100 gift card from your business. Subsequently, on August 18th, the customer's friend uses the gift card to purchase a £100 pass. At what point did your business generate revenue? The answer will be different depending on the method of accounting utilized.
Cash-based accounting
In cash-based accounting, revenue is recognized on the day your business receives payment through methods like cash, check, or credit. This means that when a purchase is made with a gift card or the internal account balance, there is no transaction to log because no actual cash has been received.
A cash-based financial report will reflect the revenue earned when a customer initially buys the gift card, but will not display the products or services subsequently acquired using that gift card.
In our example scenario, the £100 sale is recognized as revenue when the client purchases the gift card on August 1st, and no transaction is reported when the client's friend uses the gift card on August 18th.
Accrual-based accounting
In accrual-based accounting, revenue is recognized on the day a sale is made, regardless of when the payment is received. This means that when a purchase is made with a gift card or the internal account balance, the business will recognize revenue on that day and not on the day the balance was credited, or the gift card was purchased.
An accrual-based financial report will not display the initial purchase of a gift card, but will reflect the revenue earned when a customer subsequently acquires products using that gift card.
In our example scenario, the £100 sale is recognized as revenue when the client's friend uses the gift card on August 18th, and no transaction is reported when the client purchases the gift card on August 1st.
Why our Purchases report uses accrual-based accounting
When a business sells gift cards or offers account credit, accrual-based accounting is the recommended method. Since our platform provides both gift cards and an internal account balance, we use accrual-based accounting. Our Purchases report will not show the purchases of gift cards or the crediting of an internal account balance.
If you need to specifically track the purchases of gift cards, our report Purchased gift cards can provide you with the necessary information.