Cash vs. Accrual

by Larry Holmes, CPA, MBT

Taxpayers have a lot of choice when it comes to how they maintain their books and records for income tax purposes.  Many service businesses keep their books on a “cash basis”.  Other types of business that have a lot of inventory keep their books on an “accrual basis”.   Very few people understand the differences between these.  So what are the definitions of each?

Income
Cash basis means that the business records their income at the time they receive the actual payments from their customers.  The payments can be in the form of cash, credit cards, wire transfers, checks, or ACH deposits.  We encourage business owners to deposit all receipts from their customers on the same day they receive the payments.  That way the bank deposit for the day shows the total of the income for the day.
 
Accrual basis means that the business records their income at the time the service or product is delivered to their customer.  This frequently happens before the payment is received from the customer as many businesses allow their customers time to make payments.

Deductions
Tax deductions for a cash basis taxpayer occur when the taxpayer pays their bills. 

Tax deductions for an accrual basis taxpayer do not occur when the payment is made, rather they occur when the service or supplies are received by the taxpayer.  Since many businesses purchasing services and supplies do not have to pay immediately upon receiving them, the accrual basis taxpayer will typically record tax deductions sooner than a cash basis taxpayer does.  However, it is possible for a cash basis taxpayer to send out payments before receiving the services or supplies, ie. prepaying rent.

Which method has the most advantages for you?  That depends on the type of business that you have.  There are many factors that one should consider in choosing their accounting method.  It is possible for a business to adopt “hybrid” methods of accounting, as well.  The factors can become complex in a hurry so it is best to have the experts at Holmes & Associates discuss your specific business needs.  All businesses are different and unique and the most advantageous methods are unique to each business.