Selecting the appropriate accounting method is a crucial decision when starting a business. The two primary options are the cash method and the accrual method, each with its own advantages and complexities.
**Cash Method:**
The cash method offers simplicity, making it an attractive choice for many small businesses. Income is recognized when cash is received, and expenses are recorded when cash is disbursed. For example, if you purchase office supplies in November and pay the invoice that same month, the expense is deductible on that year’s tax return.
However, certain businesses are restricted from using the cash method. C corporations with gross revenues exceeding $5 million, as well as tax shelters, are generally ineligible. Professional service corporations can typically use the cash method without revenue limits, while farming corporations can use it if their gross revenues are below $25 million.
**Accrual Method:**
The accrual method is more complex, focusing on when revenue is earned or expenses are incurred, regardless of when cash changes hands. This means recognizing revenue when goods or services are provided and recording expenses when they are incurred, regardless of when payment is made.
Consider the earlier example: Suppose you order office supplies in December and receive them on December 30th but don’t pay the invoice until January of the following year. Under the accrual method, the expense is typically deductible in the year the supplies were received (December 30th), as that’s when economic performance occurred—the goods were delivered.
**Conclusion:**
The cash method is generally simpler, while the accrual method provides a more accurate picture of a company’s financial performance. Consult with a qualified tax professional to determine the most suitable accounting method for your specific business needs and circumstances.