Cash basis accounting is an accounting method that recognizes revenue and expense at the time the cash is received or paid. Alternatively, accrual accounting recognizes income at the time revenue is earned and records expenses at the time liabilities are incurred regardless of when cash is received or paid.
In the short term, cash basis accounting is less accurate than accrual accounting because transactions recorded on a cash basis affect a company's books when consideration is exchanged. C corporations, tax shelters, certain types of trusts, and partnerships with C Corporation partners are prohibited from using the cash basis accounting method under the Tax Reform Act of 1986.
Accounting on a cash basis is simpler and less expensive than accounting on an accrual basis. It is a good accounting practice for small businesses and independent contractors who do not carry inventory. Due to its ease of use, many small businesses avoid employing accountants and using complicated accounting systems. This also gives a more accurate picture of what cash is on hand.