Method of Accounting Election
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In the first year of operation, a new business, rental activity or trust must choose a method of accounting. That method must be used in the future and cannot be changed without the consent of the government (in most cases). The various methods include:
Under the ?cash method? of accounting, income is recognized when the funds are actually received and expenses are deductible when they are actually paid.
Under the ?accrual method? of accounting, income is recognized when earned regardless of whether or not received and expenses are deducted when incurred regardless of whether or not paid.
Hybrid method uses the accrual method for sales and costs of sales, but uses the cash method for general, selling and administrative expense.
Generally, a business will report less income during its growth years where accounts receivable are growing faster than accounts payable by choosing the cash method of accounting.
For a new business, a separate election is needed for accounting for inventory. The choices include:
Following are some of the issues you should consider when making the election to choose an accounting method:
· The cash method is easier, since you only need to track actual cash receipts and disbursements. If you expect your receivables and payables to be minimal, the cash and accrual methods should produce similar results, but the cash method will be simpler.
· If your business generates large receivable and small payables then you would pay tax sooner under the accrual method since the receivables would be immediately subject to tax. Vise versa, if you have high payables and small receivables, you would pay less tax under the accrual method.
Companies with inventory of products and gross receipts of over $1,000,000, regular corporations with gross receipts over $5,000,000 and other companies with gross receipts over $10 million are required to file under accrual method. If your receipts are or will soon be over that amount, you may wish to use the accrual method
Please call us if you have any questions about this election.
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