Cash basis accounting is used by a business that generally does not stock inventory but rather provides services. Taxable income is not recognized until money has been received. Expense that reduces taxable income is not recognized until money has been paid out.
Accrual basis accounting is used by a business that maintains inventory. In this type of scenario, it may take a while to turn inventory into a sale. The taxing authority allows the business to reduce the taxable income at the time the vendor’s invoice is received even if it will take a while until it is paid. To offset this graciousness, a sale regardless if paid or not becomes taxable
income at the point the customer invoice is generated.
Why doesn’t every business just uses the cash basis method of accounting? It is because the government prefers that income be recognized sooner than later. They want the tax money as quickly as they can grab it.
QuickBooks let you establish the preference for how you want to run subsidiary A/R and A/P journals as well as look at the General Ledger trial balance and Profit and Loss statements. You simply tell QuickBooks you want Cash or Accrual method and it does the rest.
Many more expensive accounting systems are written presuming that businesses that purchase their software have inventory and therefore need the Accrual method. Customization may be required to generate cash basis reporting. In some cases, it may mean setting up a separate company GL and have the subsidiary data flow into it on a cash basis via ancillary processing.
If you run a business that is service oriented rather than turning over stock, you may still consider the accrual method. If you wait to accumulate a customer’s invoice and collect the fees rather quickly, it will be to your advantage to use the accrual method especially if you are given a full thirty days to pay your regular expenses. You are using the tax break even when you haven’t paid the piper.
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