Accounting Methods – Cash vs Accrual

When starting a business, you have to determine the method for accounting and paying taxes. The two choices are the cash method and the accrual method.

Cash Method

The cash method is probably your best accounting choice if you look for simplicity. Generally, income and deductions can be claimed when payment is received or made. This is best shown with an example.

I open a small business and have to order business cards and stationery. I received the products and paid the invoice on November 18, 2021. Under the cash method, I can deduct the cost on my 2021 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. Professional Service Corporations can 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 Method

The Accrual Method of accounting is a bit more complex. Under this method, the focus is on the date the expense is incurred, not paid. Although this may seem a slight difference, it can play havoc with your books and peace of mind.

Using our previous example, assume I order business cards and stationery on December 18, 2021. I received the products on December 30 but didn’t pay the invoice until January 20, 2022. 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 vendor delivered the business cards and stationery invoice on December 30. Thus, I would deduct the expense for the 2021 tax year.

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.