Listen in with us to learn more about what cash vs. accrual basis is and the explanation of its background.
Even though we are into the New Year, there may still be some ways that a business owner can save taxes for last year. One of the things that tax reform gave us is the opportunity for more businesses to use the cash basis of accounting.
– Okay, what is that?
Okay, just to give you a little background of the cash basis of accounting. When you pay your taxes, when you’re determining what your income looks like for the year, your income is only determined by what your customers are paying you. Your deductions are determined only on when you pay that bill. So that’s the cash basis.
There’s another kind of accounting out there called the accrual basis of accounting. That one says that you earned the income, that’s when you have to pick it up in income. So in other words, you do a job which you haven’t yet been paid by your customer, you have to pick that up in your income now.
The same thing goes for deductions. Let’s say you have a bill that you haven’t paid yet. If it was incurred in that last period, you actually can deduct that on this year’s return.
– So, what is better?
It really depends. For simplicity purposes, the cash basis is better because you can almost run your business out of a checkbook. That’s what a lot of smaller businesses do. The accrual basis of accounting though, gives you better comparatives. What is does is it gives you a more true picture of where your business is really at for net income. When you pick up your income in the cash basis, and let’s say a large vendor hasn’t paid you, your income is not going to look very good until they pay you. But under the accrual basis, once you earn that service, it shows up on your income statement. So that is essentially earned income for you.
– What if you have to write that off because they’re not going to pay you?
So with the accrual basis of accounting, because you picked up that income before it was paid and if it never does get paid, you get to take a write-off for that. Under the cash basis, you don’t have a bad debt write-off because you only pick it up in your income when they pay you.
– So can you use both forms?
You can! We have a fair number of people that do this. We have one that uses the accrual basis for internal purposes so they can see truly where their business is at. And they use the cash basis a lot of times for tax purposes because it’s easier. That kind of thing can add complexity, so at that point you do want to be working with a CPA.