Cash vs Accrual Accounting Explained

Introduction
Understanding cash vs accrual accounting explained is essential for business owners, self-employed professionals, corporations, e-commerce sellers, real estate investors, consultants, and anyone responsible for financial reporting. The accounting method you choose affects when income is taxed, when expenses are deducted, how financial statements are prepared, and how CRA and Revenu Québec assess compliance. Choosing the wrong method can distort profit, create cash flow problems, or trigger tax reassessments. This guide explains the difference between cash and accrual accounting, when each applies, which method CRA allows, and how Québec rules align with federal standards.

Legal and Regulatory Framework
Cash vs accrual accounting explained is governed by the Income Tax Act, CRA business-income rules, Generally Accepted Accounting Principles (GAAP), IFRS for corporations, Accounting Standards for Private Enterprises (ASPE), GST/HST reporting rules, Québec’s Taxation Act, TP-1/TP-80 filing requirements, and CRA’s restrictions on who may use the cash method. CRA mandates accrual accounting for most businesses, with exceptions for certain professions and small unincorporated businesses.

The Cash Method of Accounting
Under the cash method, income is recorded when it is actually received, and expenses are recorded when they are actually paid. Cash accounting is simple to use and follows real cash movements. Example:
You invoice a client in November, but they pay in January. Under cash accounting, income is recognized in January.
You receive a bill in December but pay it in February. Under cash accounting, the expense is recognized in February.

The Accrual Method of Accounting
Under the accrual method, income and expenses are recorded when earned or incurred, regardless of when cash is received or paid. Example:
A November invoice is recognized in November even if paid later.
A December expense is recognized in December even if paid the following year.
Accrual accounting aligns financial statements with true economic activity.

CRA Rules on Cash vs Accrual Accounting
CRA requires most businesses to use the accrual method, including:
corporations
partnerships
manufacturers
retailers
wholesalers
e-commerce sellers
construction businesses
professional firms operating through a corporation
Cash accounting is only allowed for certain unincorporated businesses and farmers/fishers. Even when allowed, businesses must still follow GST/HST and QST rules correctly.

Who Can Use the Cash Method?
CRA allows the cash method mainly for:
unincorporated sole proprietors
certain farming/fishing businesses
professionals (only under specific transitional rules; most must now use accrual)
To use the cash method, the business must:
not hold inventory
not run a corporation
not be required by accounting standards to use accrual
If the business carries inventory (Shopify sellers, Amazon sellers, retailers, restaurants), cash method is generally prohibited.

Inventory Requires Accrual Accounting
Any business with inventory must use accrual accounting for:
sales
purchases
cost of goods sold
inventory valuation
CRA does not allow cash accounting for product-based businesses because cash method does not reflect inventory changes accurately.

GST/HST and Accrual Rules
GST/HST is usually reported on an accrual basis, even if the business uses cash accounting for income tax. Exceptions exist, such as the Quick Method or GST/HST cash reporting for small businesses. Once revenue exceeds $1.5 million, GST/HST accrual becomes mandatory.

Advantages of Cash Accounting
simple bookkeeping
easier to track cash flow
helpful for very small service-based businesses
income may be deferred until cash is received
good for businesses with inconsistent payments
Cash accounting reflects cash availability more clearly.

Disadvantages of Cash Accounting
not allowed for most businesses
cannot track receivables or payables
inventory cannot be reported correctly
less accurate financial statements
cannot be used for corporations
limited use under CRA rules
Cash accounting often underestimates income and expenses at year-end.

Advantages of Accrual Accounting
provides accurate financial position
matches revenue and expenses to periods
accepted under GAAP and ASPE
required for corporations and most businesses
improves lender confidence
provides better long-term planning and profitability insights
tracks receivables, payables, and inventory properly

Disadvantages of Accrual Accounting
requires more complex bookkeeping
requires year-end adjustments
may create taxable income before cash is received
can make cash flow management difficult if not monitored
Still, accrual accounting is the standard for financial reporting.

Switching from Cash to Accrual Accounting
Businesses may need to switch to accrual when:
incorporating
growing beyond sole proprietor level
holding inventory
selling digital products at scale
expanding to multiple provinces
CRA must be notified when switching, and adjustments may be required to avoid double-counting income.

Québec-Specific Requirements
Québec follows federal rules for accounting methods. TP-80 forms require accrual calculations for business income. QST filing also follows accrual rules unless a small-supplier exception applies. Québec businesses with inventory or employees must use accrual accounting.

Common Mistakes Business Owners Make
mixing cash and accrual methods
deducting expenses before incurring them
failing to report unpaid invoices
not adjusting for accounts receivable
using cash method illegally while holding inventory
incorrectly reporting GST/HST
These mistakes frequently trigger CRA or ARQ reassessments.

Key Court and CRA Positions
Courts consistently uphold CRA’s authority requiring accrual accounting. Cases reinforce that inventory-based businesses cannot use cash accounting. CRA publications confirm that most professions and corporations must apply accrual rules.

Why CRA and Revenu Québec Audit Accounting Methods
inconsistent reporting year to year
large cash variances
inventory mismatches
incorrect GST/QST reporting
unreported receivables
improper expense timing
CRA reviews accounting-method selection as part of business audits, especially for growing e-commerce businesses and incorporated service providers.

Mackisen Strategy
Mackisen CPA determines the correct accounting method for your business, prepares accrual-based financial statements, manages GST/QST compliance, restructures bookkeeping systems, transitions businesses from cash to accrual accounting, and ensures clean, audit-proof records. For corporations, we implement ASPE standards and accrual adjustments required by financial institutions and lenders.

Real Client Experience
A Montréal retailer used cash accounting incorrectly and underreported income; Mackisen corrected filings and prevented penalties. A service-based consultant needed accrual statements for a bank loan; we prepared accurate financials. A Shopify seller miscalculated inventory and COGS due to cash accounting; we rebuilt accrual-based statements. A corporation mixing cash and accrual triggered a CRA audit; Mackisen handled adjustments and closed the audit successfully.

Common Questions
Can I choose cash accounting if incorporated? No — corporations must use accrual.
Does CRA allow cash accounting for e-commerce? No — inventory requires accrual.
Do I charge GST/HST using cash or accrual? Usually accrual unless eligible for cash reporting.
Is accrual better for financial statements? Yes.
Can I switch methods? Yes with CRA approval and adjustments.

Why Mackisen
With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps business owners understand cash vs accrual accounting explained and choose the correct method for tax compliance, financial accuracy, and growth. Our expert team ensures proper reporting, clean bookkeeping, and full protection during CRA and Revenu Québec audits.