Accrual vs Cash Accounting for AP

Accrual accounting records transactions when they occur -- when an invoice is received, an expense is recognised, regardless of when it is paid. Cash accounting records transactions when cash changes hands -- an expense is recognised only when the payment is made. For accounts payable, this distinction determines when supplier invoices appear in the income statement and how the AP balance on the balance sheet is calculated.

Under accrual accounting, the AP ledger represents real outstanding liabilities: invoices that have been received and processed but not yet paid. The AP balance on the balance sheet shows what the business genuinely owes to suppliers at the date of the balance sheet. Under cash accounting, there is no AP balance in the same sense -- expenses are recognised when paid, so unpaid invoices do not appear as a balance sheet liability.

Which basis Australian businesses must use

Australian businesses must use accrual accounting for income tax purposes once their annual turnover exceeds AU$2 million. Below this threshold, they may use either accrual or cash basis. For GST, businesses with annual turnover above AU$2 million must use the accruals (invoice) basis for reporting GST on the BAS; smaller businesses can elect to use the cash basis. The accounting basis and the GST reporting basis can be different, which creates reconciliation complexity -- a business using cash basis accounting but accruals basis for GST must track both paid and unpaid invoices to complete its BAS correctly.

For management reporting purposes, accrual accounting is almost universally preferred regardless of size, because cash basis financial statements do not accurately reflect the financial position of the business. A business with AU$500,000 in unpaid supplier invoices at 30 June has a real liability that should appear on the balance sheet -- cash basis reporting makes this liability invisible until the invoices are paid, which may be in the next financial year.

Switching from cash to accruals

When a business transitions from cash to accrual accounting, the AP process must change to record invoices when received rather than when paid. This typically requires: setting up the AP module in the accounting system to track unpaid invoices, implementing an invoice approval process to ensure invoices are processed before payment rather than simply recorded at payment, establishing the GRNI accrual process for goods received but not yet invoiced, and performing a transition-date cleanup to identify all outstanding supplier obligations that have not been recorded under the cash basis.

The transition-date catch-up is often the most demanding part of switching to accruals. Every supplier invoice that was received before the transition date but not yet paid must be entered and backdated to create an opening AP balance. This exercise also surfaces invoices that may have been overlooked under the cash basis -- where no payment was made (and therefore no record was created) -- converting invisible liabilities into visible balance sheet obligations.