Accounting Methods – Cash and Accrual
Picture: Illustration Accounting Methods |
Accounting Methods – Cash and Accrual. When starting a business, you have to determine the method you are going to use for accounting and paying taxes. The two choices are the cash method and the accrual method.
Cash Method
If you are looking for simplicity, the cash method is
probably your best accounting choice. Generally, income and deductions can be
claimed when payment is actually received or made. This is best shown with an
example.
I open a small business and have to order business cards and
stationary. I receive the products and pay the invoice on November 18, 2005.
Under the cash method, I can deduct the cost on my 2005 tax return.
Some businesses are restricted from using the cash method. C
corporations may only use the cash method if they have less than $5 million in
gross revenues for a particular year. Accounting Methods – Cash and Accrual
Professional Service Corporations can use the cash method
without limit, while farming corporations can due so if gross revenues are less
than $25 million. Tax shelters are prohibited from using the cash method.
Read Also: Accounting Outsourcing Nitty-Gritty that you need to Know
Accrual Method
The Accrual Method of accounting is a bit more complex.
Under this method, the focus in on the date the expense is incurred, not paid.
Although this may seem a small difference, it can play havoc with your books
and piece of mind.
Using our previous example, assume I order business cards
and stationary on the December 18, 2005. I receive the products on December
30th, but don’t pay the invoice until January 20, 2006. When can the expense be
claimed? It depends on when economic performance occurred.
Generally, economic performance occurs when goods or
services are provided to you. In the above example, economic performance would
arguably occur when the business cards and stationary were delivered with the
invoice on December 30th.
Thus, I would be able to deduct the expense for the 2005 tax
year. Accounting Methods – Cash and Accrual.
In Closing
As you can see, the cash method is the easier of the two
accounting methods. To determine the best method for your business, speak with a
tax professional.