Using Accrual Basis Accounting in Your Personal Finances

Accrual basis accounting, also known as accrual accounting, is the method most used by businesses, while most people use cash basis accounting for their personal finances. However, accrual accounting does have a few benefits that you can take advantage of in your own personal budget as well. The best part is that, because your personal finances aren’t regulated, you don’t have to follow the strict accounting rules that businesses have to obey. You can use accrual accounting in some areas of your personal finances and use cash accounting in others, depending on which method works best.

So what is the difference between accrual accounting and cash accounting? Essentially accrual accounting is recording your income and expenses when they occur, while cash accounting is recording your income and expenses when money changes hands. Still not clear? Let’s look at some examples.

With cash accounting, if you use your credit card, you would wait until you got your credit card bill at the end of the month to write down how much you spent because this is the point that you actually pay the bill. With accrual accounting, you would record the purchase in your budget on that date that you made it, even if the bill isn’t due for several weeks. Even though you haven’t paid for it yet and the money is still in your bank account, your budget shows that that amount has been spent.

You can see the advantage of using accrual accounting to keep track of your credit card expenses; In fact, you may even be doing this already. By writing down your purchases when you buy them, you won’t be surprised by your credit card bill at the end of the month. Also, according to your budget you have already spent the money, so as long as you don’t go over budget, you will have enough to cover your credit card bill in full. Imagine paying off your credit card every month and not having to worry about how much interest is accruing or how long it will take to pay off your credit card debt. Whether you call it accrual accounting, or just good credit card management, keeping track of your credit card purchases when you buy them instead of when you pay the bill just makes sense.

You can use the idea of accrual accounting to pay reoccurring bills that aren’t due every month like your car insurance. Large payments like these can really stress your budget during the month that they are due if you aren’t prepared for them. You can use accrual accounting principles to set aside a portion of the bill every month so that when it comes time to pay, you have enough money on hand. For example, if you have a $300 car insurance premium due every three months, you would “pay” $100 every month toward the car insurance premium. Now, you aren’t actually sending a check to your car insurance carrier, but you are subtracting $100 from your budget each month and setting it aside for your car insurance premium. When the bill comes due, instead of having to come up with the full $300, you only have to subtract the usual $100 from your monthly budget and add it to the $200 you had set aside the previous two months.

You can even use accrual accounting to prepare for future non-fixed expenses like holiday shopping, a vacation or a future car purchase. Estimate how much money you will spend and divide this amount by the length of time you have until you will have to pay the bill. Subtract this amount from your budget every month and set it aside until you need to use it. Basically you are paying for your future purchases with monthly installments long before you actually make the purchase. How would you like to be able to pay cash for your cars and vacations? If you plan far enough ahead, and are diligent about setting the money aside, this is a real possibility.

The key to using accrual accounting in your personal finances is to look at your budget sheet and not at how much money is actually in your bank account. According to accrual accounting, once you have subtracted a purchase or installment from your monthly budget, the money is gone and can’t be used for anything else. When you look at your bank account and see how much is actually there, you may be tempted to use it, but you must resist! Remember that this money has already been spent on something else. It may help to transfer the “spent” money into a separate savings account until the bill arrives so you are not tempted to use it.