Cash And Accrual Accounting Methods

An accounting method is a set of rules that are used to determine when income and expenses are reported. When starting a business, you will need to determine the method you will be using for accounting and paying taxes. The 2 main choices are the cash method and the accrual method of accounting.

Cash Accounting Method 

If you're looking for simplicity, the cash method of accounting is probably your best accounting method.  Generally, income and deductions can be claimed when payment is actually received or made.  This is best shown by having an example. 

Let's say you open a small business and have to order business cards and stationary.  You receive the products and pay the invoice on November 18, 2011.  With the cash method, you can deduct the cost on your 2011 tax return. 

Some businesses are restricted from using the cash method of accounting.  C corporations can only use the cash method if they generate less than $5 million in gross revenues for a particular year.  Professional Service Corporations are able to use the cash method without limit, while farming corporations can do so if gross revenues are less than $25 million.  Tax shelters are prohibited from using the cash method. 

Accrual Accounting Method 

The Accrual Method of accounting is a little more complex.  Under this method, the main focus in on the date the expense is incurred, not paid.  Although this may seem to be a small difference, it might play havoc with your books and peace of mind. 

Using our previous example, let's assume that you order business cards and stationary on the December 18, 2011.  You get the products on December 30th, but don’t pay the invoice until January 20, 2012.  When can this expense be claimed on your taxes?  It all depends on when economic performance took place. 

Typically, economic performance occurs when goods or services are provided to you.  In the above example, economic performance would arguably happen when the business cards and stationary were delivered with the invoice on December 30th.  Thus, you would be able to deduct the expense for the 2011 tax year. 

In closing 

As you can see, the cash method is the easier of the two accounting methods.  If you would like to determine the best method of accounting for your business, it is best if you consult a tax professional.