Tuesday, May 15, 2007

“Cash” Basis or “Accrual” Basis. Which is Best for Retailers?

This article was written by Dick Ginnaty, CPA

When a business starts, one of the decisions that needs to be made is whether to report your business for tax purposes on the “cash” basis or on the “accrual” basis. This choice is indicated on the first tax return that is filed for the business. This choice should be made with the thought of maximizing the tax benefit of the choice.

Under the cash basis, revenues are reported when received, and expenses are recorded when paid. Under the accrual basis, revenues are recorded when earned, and expenses are recorded when incurred. Under the accrual method, your receivables count as taxable income, and your expenses that are not yet paid (i.e. accounts payable) are deductible.

Many times beginning businesses will chose the cash basis of reporting because they get to delay paying taxes on their open receivables until they have been paid. This may work for many businesses but it may not be the best choice for retailers, and web based e-commerce sellers.

For many of those they don’t have any receivables. They get paid at the time of purchase, or even prepaid, but they do have expenses that haven’t been paid yet that relate to the period (i.e. utility bills, telephone bills, wages, commissions etc.). For these businesses the accrual method is better because under the accrual method they won’t recognize any more income (they have already received all they are going to get) and yet they can deduct some expenses that they haven’t paid for yet. It is the very best possible position.

So think hard about your situation, and good luck. By the way, if you already have selected the cash method of reporting, a change is possible but it requires the approval of the IRS commissioner. Luckily, the change from cash to accrual accounting is one qualifying for “automatic consent”, but it still requires an application using Form 3115 following the steps outlined in Revenue Procedure 2002-9.

Good luck and here’s hoping it “all adds up” for you.

(If there is any area in accounting or tax that you think needs to be addressed in this newsletter please e-mail Dick at Ginnatycpa@aol.com and if it is of general interest, he will address it in future articles)