Cash Basis to Accrual: How Do You Stop Reversing the Adjustments?
Cash basis follows money. Accrual basis follows earning and incurrence.
Revenue conversion
Cash-basis revenue reflects collections while accrual revenue reflects revenue earned. If accounts receivable increases, the company generally earned more revenue than it collected in cash, all else equal.
Expense conversion
Cash payments are not automatically accrual expenses. If accounts payable increases, the company generally incurred more expense than it paid in cash.
Prepaid expenses
An increase in prepaid assets can indicate some cash payment belongs to a future period rather than current expense.
Unearned revenue
An increase in unearned revenue can indicate some cash received is not yet current-period revenue.
Use T-accounts
When signs become confusing, draw accounts receivable, accounts payable, prepaid expenses, and unearned revenue and solve the rollforward.
The takeaway
Do not memorize signs without understanding the underlying account movement.
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FAQ
If AR increases, is accrual revenue generally higher than cash collections?
Yes, all else equal.
If AP increases, are accrual expenses generally higher than cash payments?
Yes.
Should I memorize signs?
Understanding the account movement is more reliable.