Cash vs. Accrual Accounting – A Complete Guide by a Montreal CPA Firm Near You

Introduction

One of the most important decisions a small business owner must make is choosing between cash accounting and accrual accounting. This choice affects how income is reported, when expenses are deducted, how financial statements look, and how CRA views your business. Many entrepreneurs pick a method without understanding the tax consequences, leading to cash-flow problems, inaccurate reporting, or CRA adjustments. This guide explains the difference between cash and accrual accounting, who is allowed to use each method, and how it affects taxes for Canadian businesses.

Legal and Regulatory Framework

Under the Income Tax Act, most businesses in Canada must use the accrual method for tax purposes, recognizing income when earned and expenses when incurred. However, certain businesses—such as farmers, fishers, and some self-employed professionals—may use the cash method. CRA requires consistency in the accounting method chosen and may challenge taxpayers who attempt to manipulate income by switching methods without proper justification. Financial statements for corporations generally use accrual accounting under ASPE or IFRS, while sole proprietors use the T2125.

Key Court Decisions

In Formulaire v. Canada, CRA successfully denied a taxpayer’s attempt to defer income using cash-based recognition because accrual rules applied. In Canderel Ltd. v. Canada, the Supreme Court emphasized that income must be computed using a method that clearly reflects profit, forming the foundation of accrual accounting. In Tonn v. Canada, courts held that expenses must match revenue in the appropriate period, reinforcing accrual principles. These decisions confirm that CRA prioritizes accuracy and consistency in income measurement.

What Is Cash Accounting?

Cash accounting recognizes revenue when cash is actually received and expenses when cash is actually paid. It provides a simple picture of a business’s cash flow. This method is generally used by: farmers, fishers, certain professionals in limited circumstances, and very small unincorporated businesses when allowed. Cash accounting is straightforward but may distort profitability because it ignores accounts receivable, accounts payable, and inventory timing.

What Is Accrual Accounting?

Accrual accounting recognizes revenue when earned and expenses when incurred—regardless of when money changes hands. It provides the most accurate representation of business profitability and is required for: corporations, most service businesses, any business with inventory, and any business of significant size. Accrual accounting offers better financial insight but requires careful bookkeeping and proper documentation.

Cash vs. Accrual: Key Differences

Revenue: Cash = when paid; Accrual = when earned.
Expenses: Cash = when paid; Accrual = when incurred.
Inventory: Cash = not required; Accrual = must track COGS, inventory changes.
Complexity: Cash = simpler; Accrual = more detailed.
Tax planning: Cash allows some timing benefits; accrual reflects true business performance.
CRA compliance: Accrual is required for most businesses and is more audit-proof.

Which Method Is Best for Your Business?

Cash accounting is beneficial when: you want simplicity, you receive payments immediately, or your business is eligible under CRA rules. Accrual accounting is best when: you issue invoices, carry inventory, have significant payables or receivables, want accurate profitability, or plan to grow. Most incorporated businesses, even small ones, use accrual because it produces more reliable financial statements for lenders and investors.

Impact on Taxes

Under accrual accounting, you may owe tax on income you have earned but not yet collected, which can create cash-flow challenges. However, you can also deduct expenses earlier, even before they are paid. Under cash accounting, tax is driven entirely by cash flow, allowing income deferral if receivables are delayed—but CRA restricts this method for most industries.

Inventory and the Accrual Requirement

If your business buys and sells goods, CRA requires accrual accounting because inventory must be tracked using cost-of-goods-sold (COGS) rules. You must record: opening inventory, purchases, freight, customs duties, adjustments, and closing inventory. Cash accounting cannot properly track COGS and is therefore not allowed.

Common CRA Issues With Accounting Methods

CRA frequently audits businesses for: inconsistent use of cash vs accrual methods, manipulating timing to avoid tax, improper treatment of prepaid expenses, missing accounts receivable tracking, unreported inventory, and switching methods without an opening balance adjustment. Businesses that fail to record income when earned or expenses when incurred often face reassessments.

Mackisen Strategy

At Mackisen CPA Montreal, we help clients choose the right accounting method, set up proper bookkeeping systems, maintain accurate accrual records, manage inventory, prepare T2125 or T2 filings, and ensure CRA compliance. We also assist with transitions between cash and accrual accounting by preparing detailed opening balance adjustments, correcting prior-year errors, and rebuilding financials where necessary.

Real Client Experience

A Montreal contractor using inconsistent accounting methods faced CRA audit; we reconstructed records using accrual accounting, avoiding penalties. A small online shop incorrectly using cash accounting required complete inventory adjustments—our team corrected filings and prevented reassessment. A professional incorporating their practice transitioned from cash to accrual under our guidance with no tax disruption.

Common Questions

Can any business use cash accounting? No—only certain eligible professions. Does CRA allow switching methods? Yes, but only with proper adjustments. Which method is better for loans? Accrual—banks prefer accurate financial statements. Does accrual create more tax? Not necessarily—it improves accuracy, not the total tax bill.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal ensures your business uses the right accounting method to stay compliant, optimize taxes, and produce clear, reliable financial information. Whether you’re a startup or an established corporation, we help you build strong financial foundations.