Accounting Methods refers to the basic guidelines that businesses follow in order to maintain financial records and prepare their yearly business tax returns. Essentially, there are two types of accounting methods used: The Cash Basis Method and the Accrual Method.
Generally, most small business owners do not pay much attention to the methods of accounting used in their industry. However, as the sole business proprietor, it is essential to be able to differentiate the two methods, the eligibility of usage and consequences of using one method over the other. This decision must take into account the nature of your business and how you would like to maintain your financial records. Both methods have their advantages and disadvantages and necessary research must be conducted in order to make the right choice.
Accounting Method Financial Qualifications
Most businesses are free to use Accrual accounting, but only businesses with less than $25 million in gross revenue in the last three tax years can use cash basis accounting to the IRS.
Our highly qualified tax professionals will evaluate your situation and guide you towards the appropriate accounting method for your business needs to maximize the tax benefits.
Accounting Methods FAQs
The cash basis accounting method is a simple system of tracking revenue when it is received. This method is also a short-term, real-time picture that tracks expenses only when they are getting paid out.
The cash basis accounting method is acceptable for businesses with less than $25 million in gross revenue in the last three tax years.
With this method of accounting, small business owners are often able to use accounting software or bookkeeping. A CPA is also not necessary with the cash basis method of accounting.
This method provides the opportunity to see the flow of cash on an accurate short-term assessment.
Instead of dealing with income tax on invoices issued, a business only pays an income tax on cash received.
For companies that don’t hold inventory, this method if of convenience as the balance sheet is an accurate representation without other consideration.
Under the GAAP requirement, the cash basis method is not accepted so public companies and larger corporation companies are not able to use this method.
Limitation of annual revenue over $25 million for companies prevents using the cash basis method of accounting
Financial statements may show an inaccurate representation of profit.
Unlike the cash basis method, accrual method expenses and revenue are recorded when they are generated or earned rather than when the cash is received or expensed.
Companies that fall under GAAP are required to use this method. This is required for companies with revenue over $25 million.
This method of accounting provides a better realistic picture of actual income and expenses and can provide a more transparent lens of the business that the cash method cannot provide.
The accrual method does not provide insight into the actual cash flow of a business, oftentimes letting businesses appear to be worth a high value even when bank accounts have no monetary value in them.