Accrual Basis

Today TaxMama hears from Nunya in the TaxQuips Forum who was advised by an EA “that typically she prefers accrual, but I can’t really recall for sure or why.  She was giving a small [business] seminar.”

Dear Nunya,

Ever since I read your note, I’ve been thinking about why anyone would prefer using accrual-based accounting as a general rule.

Then it became obvious to me. Of course! She’s talking about using accrual for book purposes. When you set up your accounting system on an accrual basis, that means you enter all your accounts payable into the system, as well as all your own billing. This can help you do budgeting, schedule payments, and better manage cash flow and debt.

That makes perfect sense – and is excellent advice.

However, for tax purposes, you are allowed to file your tax return on a cash basis.

Yes, you may use a different accounting method for books and taxes.That’s why corporate and partnership tax returns have an area on the balance sheet page called Schedule M-1 – to reconcile the books to the tax return. (typically on page 4 or 5)

For most businesses, especially service businesses, filing on a cash basis gives you the best tax advantage. Usually service businesses have higher accounts receivable (money due TO you) than accounts payable (money you owe) at the end of the year.

In fact, manufacturing, wholesaling and government contracting are in a similar position. I was just speaking to someone this weekend who outlined his manufacturing cash flow – he must pay his suppliers and producers before they ship to him – or within 45 days. However, he doesn’t get paid by his department stores for at least 60-90 days after delivering the goods.

Who wants to pay taxes on income you haven’t received yet at the end of the year?

And remember, you can find answers to all kinds of questions about tax vs books, accounting methods, and other tax issues, free. Where? Where else? At www.TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the join TaxMama.com link – it’s free!]

Please post all Comments and Replies in the new TaxQuips Forum

3 thoughts on “Accrual Basis

  1. TaxMama says:

    Thanks Annette, excellent point.

    Carolyn, you’re only half right.
    It doesn’t even out.

    Businesses paying taxes on the accrual basis will be paying taxes on accounts receivable they may never collect. That is a big problem in medical practices and other service businesses. In fact, it’s a big problem these days in many businesses, as long-term, solid clients are going out of business and don’t pay their bills.

    It’s an issue for growing businesses, in the wholesale sector, where they sell ever more merchandise each year – with 90 day ARs. Each year, their outstanding A/R at year end is greater. Why pay tax on it a year before you get the money?

  2. Carolyn Sellers says:

    The reason a company uses accrual based accounting is that it matches revenue and expenses for the month. It is the only accurate way to know what the bottom line is.

    As far as paying taxes on money not received, that evens out.

  3. Annette Corey says:

    One of the best reasons for running a business on an accrual basis is for analyzing payroll expense. If you do not accrue wages as they are earned, rather than paid, you may have your Christmas wages or year ned bonus showing up in the next year! This makes it difficult to budget and compare year to year expenses.

Leave a Reply