Accrual vs Cash Accounting: What’s the Difference in a Medical Practice?

To maintain clean books and pay taxes, your medical practice has to decide whether to use accrual vs cash accounting. Each approach is valid, offering different benefits and drawbacks. Here is what you need to know about accrual vs cash accounting, and how to manage your accounts receivables and revenue recognition depending on your choice.

Accrual vs Cash Accounting: The Basics

Accrual accounting recognizes revenue and expenses based on the date your practice incurred them. Under accrual accounting, claims submitted to payers but not yet paid count as revenue. Cash accounting, in contrast, recognizes revenue and expenses when you receive or pay them, respectively. Under cash accounting, you do not count the claims you submit to payers for reimbursement as revenue until you receive payment.

Accrual accounting gives a more accurate picture of the financial position of your practice. The accrual method shows you the full extent of your liabilities and accounts receivable, even those that you have not yet paid or received. But accrual accounting can be complicated to implement.

Most medical practices without outside investors choose to use cash accounting. Cash accounting is much simpler, saving you time and money. Cash accounting also lets you pay taxes only on the revenue you received during a year, not any still-outstanding accounts receivable. Finally, for practices that pre-purchase goods, like oncology practices, the cash accounting method lets you deduct those costs when you purchase the medication. Under accrual accounting, you would instead deduct the cost of prescription drugs when you provide them to a patient. With longer-storage items, the accrual method can create lengthy gaps between your purchase date and when you can deduct the cost of the purchase.

Accrual vs Cash Accounting: Taxes

Under accrual accounting, you pay taxes on the income earned, or billed, within the tax year minus any expenses incurred during the tax year. With cash accounting, you pay taxes on the income received during a tax year minus expenses paid during the tax year. While accrual accounting better matches income and expenses to the correct year, cash accounting has some benefits for medical practices. Under accrual accounting, the IRS treats your accounts receivable as income for the tax year, whether or not you received the payments. Under cash accounting, you do not need to pay taxes on bad debt or denied or pending claims. With cash accounting, you only pay taxes on the income you receive, not the income you earn.

The IRS allows medical practices that meet certain requirements to use cash accounting for tax purposes. If you elect to use cash accounting, you can later change your mind and switch to accrual accounting. However, the reverse is more difficult—the IRS must approve a change from accrual accounting to cash accounting. For practices with large inventories of pre-purchased supplies, like oncology practices, special rules for accounting for inventory purchases and sales may apply.

Choosing Between Accrual vs Cash Accounting

Small practices often default to the simplicity of cash accounting. It is easy to implement and supported by most EHR and EPM systems. With cash accounting, you do not pay taxes on medical bills that are still outstanding at the end of the year. Solo practices, partnerships, S-Corporations, and qualified personal service corporations can all use the cash accounting method for IRS purposes.

Accrual accounting is more complex but provides a better picture of your practice’s financial position. Hospital systems, large practices, and private equity-backed practices often use accrual accounting for this reason. With cash accounting, problems with accounts receivable can go unnoticed, as unpaid accounts stay off the books until your practice receives a payment. Accrual accounting helps your practice spot problems with accounts receivable more easily, as this approach counts each claim as income when you file it, regardless of how long it takes to be paid.

Both accounting methods are valid for most practices. If you are unsure which approach to take, remember that the IRS will let your practice change from cash to accrual accounting at any time—although making the switch from accrual accounting back to cash is more complicated. Your EHR and EPM system can support either accounting approach.

Accrual Accounting: The Complexities in Medical Practices

Accrual accounting becomes difficult in medical practices because no medical practice is paid what they charge. There is a myriad of factors contributing to this: inflated charges, different contractual reimbursement rates, denials, and bad debt. These factors can make it difficult to determine what the true accounts receivable is that should be recognized as revenue. There are different strategies that can be utilized to determine revenue, however, each should be investigated carefully as they can have downstream impacts on your revenue cycle. One popular strategy is to take contractual adjustments at charge entry but this can cause issues with ERA posting and unnecessary credit balances. Another strategy is to use business intelligence to look at historical payments and payer contracts to determine typical payments received to help determine likely revenue. If you're looking into what solution would work best for your company for accrual-based accounting, it is a good idea to consult with a firm that has done in with your system before to advise you. Inaccurately recognizing revenue can have a negative impact on your business.

How TempDev Can Help with Accrual vs Cash Accounting

TempDev can help your practice implement cash or accrual accounting with your NextGen EPM. They can also help you build the proper reporting or business intelligence needed to accurately recognize revenue. TempDev also has experience helping clients transition from cash to accrual accounting. Whether you are just starting out or are looking to fine-tune your approach, the experts at TempDev can help. TempDev also offers staff augmentation services, including temporary revenue cycle managers and billers, to help with your revenue cycle needs if you need to get caught up from a transition.

Call us at 888.TEMP.DEV or contact us here to get started implementing the best accounting approach for your practice.