Cash Method vs. Accural Method - Selecting an Accounting Method for Your Business

Cash Method vs. Accrual Method - Selecting an Accounting Method for your Business

When setting up a bookkeeping system for your company, it is important to understand the definition of the cash method and the accrual method of accounting. Under the cash method, revenue and expenses are recorded according to the flow of cash in and out of the business. Under the accrual method, revenue and expenses are recorded when incurred, usually in the absence of a cash transaction. The cash basis is an easier concept to work with but does not always give you a true picture of business operations. The accrual basis will give you a more accurate picture of your company’s results of operations, but requires a bit more work.

Characteristics of the Cash Basis:

a. Deduct your business expenses when paid. ( Ex: Record expenses on the books only when cash goes out the door)

b. Record Income when you receive payments from your customers. (Ex: Recognize income on the books only when cash comes in the door)

c. At year end, only expenses paid during the year and income received during the current year will be recorded on the tax return. (Ex: If customers were invoiced a total of $75,000 late in December and payments on those invoices have not been received by December 31st, that income does not show up on the tax return. Likewise, if invoices from your supplier totaling $75,000 are being held but not paid by December 31st, those expenses are not deducted on the tax return)

Characteristics of the Accrual Basis:

a. Business expenses are deducted when you receive goods or services usually before they are paid. (Ex: Record expenses on the books when goods/invoices are received from your suppliers, before you send your payment.)

b. Revenue is recognized when you provide goods or services to your customers, even if payment has not been received. (Ex: Record income on the books when services are rendered to customers or goods are sold, prior to receiving payment)

c. At year end, unpaid invoices/receivables to customers could be sitting on the books which create taxable revenue for the current year, even though payment has not been received from the customer.

d. Likewise, at year end, unpaid bills to vendors/payables could be recorded on the books for expenses that have not yet been paid. These expenses will reduce taxable income.

Situations where the Accrual Method is required:There are some situations where the accrual method of accounting is required. However, for most small businesses, these situations probably do not apply. If you have a corporation that has annual gross revenue of $5million or more, you must use the accrual method. Additional if you carry inventory on the books or if your business is engaged in farming operations, you might be required to use the accrual basis.

Change in Method of Accounting:

Once a method of accounting is adopted, this method needs to be followed year after year for tax purposes. However, if there are specific reasons to change methods that might prove to be more advantageous to your business, you might consider changing methods. To change to a different method of accounting used in reporting taxable income on your business tax return, the corporation must file a Form 3115 – Application for Change of Accounting Method to receive approval from the IRS.

Small business accounting software will usually allow the presentation of the financial statements on either a cash or accrual basis. However, for tax purposes, arbitrarily switching back and forth between the two methods is not allowed.

In Conclusion, for most small business with revenue under $5 million, it is probably best to use the Cash method, especially if those businesses carry large receivable balances on the books. By carrying receivables, this means that you have invoiced customers, but not actually received payment from these customers. At tax time, those invoices are disregarded and will Not result in taxable income. Because, under the Cash method, only cash actually received during your tax year has to be reported as income on the tax return. For businesses that do not carry large receivable balances, it might be more beneficial to use the Accrual basis of accounting. This would allow deductions for business expenses that have been incurred but not yet paid. Some businesses plan on accelerated spending at year end for this purpose.

Conversion to Roth IRA

Restricted from a Roth IRA? Not Anymore

Starting 2010, more people can convert to a Roth IRA. That's because income limits and tax-filing restrictions go away!

Roth Conversion Details

• Who: All taxpayers, regardless of income or tax-filing status

• What: Conversions from a traditional, SEP or SIMPLE IRA – or qualified rollover contributions from an employer plan (401(k), 403(b), etc.) – to a Roth IRA

• When: Starting January 1, 2010

• Why: Take advantage of tax-deferred growth and tax-free withdrawals.1 No required minimum distributions.2
  

Act Now
Converting to a Roth IRA has many potential benefits. But there are important things to consider, such as your retirement goals, account status and potential tax implications. Taxpayers who convert to a Roth IRA in 2010 have the option to report 50% of the taxable conversion in 2011 and 50% in 2012. In subsequent years, taxpayers will have to pay all taxes in the year they convert.

Consult our offices and ask your tax advisor, as not all states have adopted the federal rules, and there may be differences in federal and state taxation of a Roth IRA conversion.

1 Must be qualified Roth IRA distributions.

2 Applies to the original account owner only. Beneficiaries would be required to withdraw required minimum distributions.
State tax treatment may vary.


Are You Conversion Bound?

Talk to someone at Tahim and Associates about the Roth IRA conversion and whether it's right for you.

Ready to talk to someone now? Call Tahim and Associates at:

714-772-4744

2010 Tax Calendar

2010 Tax Calendar

January 15 — Individual taxpayer’s final 2009 estimated tax payment is due unless Form 1040 is filed by February 1, 2010, and any tax due is paid with the return.

February 1 — Most employers must file Form 941 (Employer’s Quarterly Federal Tax Return) to report Medicare, social security, and income taxes withheld in the fourth quarter of 2009. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until February 10 to file the return. Employers who have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944 (Employer’s Annual Federal Tax Return).

— Give your employees their copies of Form W-2 for 2009. If an employee agreed to receive Form W-2 electronically, have it posted on the website and notify the employee.

— Generally, give annual information statements to recipients of certain payments you made during 2009. You can use the appropriate version of Form 1099 or other information return. Form 1099 can be filed electronically with the consent of the recipient.

— File Form 940 [Employer’s Annual Federal Unemployment (FUTA) Tax Return] for 2009. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it is more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 10 to file the return.

— File Form 945 (Annual Return of Withheld Federal Income Tax) for 2009 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on pensions, annuities, IRAs, etc. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 10 to file the return.

March 1 — The government’s copy of Form 1099 and Form W-2 series returns (along with the appropriate transmittal form) should be sent in by today. However, if these forms will be filed electronically, the due date is March 31.

March 15 — 2009 income tax returns must be filed or extended for calendar-year corporations. If the return is not extended, this is also the last day for calendar-year corporations to make 2009 contributions to pension and profit-sharing plans.