Cash basis and Accrual basis
“In which month should you write off the expenses?” From the point of view of accounting theory, there are two methods of note: the cash method and the accrual method. According to the cash method, income and expenses are recognized when there is a movement of cash flows associated with them. The cash method is convenient to use when the enterprise is small, and the results of its activities are highly dependent on incoming and outgoing cash flows. Bookkeeping can also be used for processing the information on income and expenses.
The main rule of the accrual method is that the accounting of income and expenses are not related to the actual movement of money. The cash method reflects information about when the funds are received and when spent. For many managers, this information is important and specific.
Expenses are recognized in the reporting (tax) period in which these expenses arise based on transaction conditions. If the transaction does not contain such conditions and the relationship between income and expenses cannot be determined clearly or is determined indirectly, expenses are distributed by the taxpayer independently.
Benefits of Cash Method
In the cash method, income is considered received on the day of receipt of the funds. Or at the time of receiving any property, services, or performance of work as payment, which must be confirmed by the act. Shortcomings level the advantages of the cash method. Additionally, benefits from the application of the cash method can be different for specific organizations, from the structure of their activities. There is a list of certain types of activities in which this method is justified and allows you to reduce tax costs.
The cash method is convenient because the main principle of accounting is cash flow and no situation typical for the accrual method. When work is completed, money has not yet been received, but implementation is necessary to pay taxes. Such a principle is understandable for small businesses, and if the organization works by providing a deferred payment to customers. And the question arises that who is entitled to apply the specified accounting system? And in what is this application mandatory?
The cash method means that receiving an advance is also an income and necessary to pay taxes even if the work has not yet been completed. Also, the advance may have to be repaid. The cash method is characterized by the fact that the actual receipt of cash determines income. Income will be considered received if the obligation to pay is repaid in another way – offset, compensation, and innovation. But even in this case, those incomes which are received because of this operation will be considered. For example, if an agreement to repay the debt for completed work and compensation less than the amount owed, the income will reflect the amount received by compensation rather than the one that had to pay.
An important feature of income accounting for the cash method is the fact that the advances received are also recorded as income. The advance can be returned – the client can change his mind, the organization may not fulfill its obligations; that is, the situation with the return of the advance often occurs.
The cash method is one of two methods for recognizing the income and expenses provided for by the Tax Code. Let us remind, that the firms paying the profit tax, can independently choose a cash method or an accrual basis. Businesses and individual entrepreneurs who have switched over to a simplified taxation system are obliged to apply the cash method.
In the cash method, income and expenses cannot be considered when calculating the tax until the actual cash flow has occurred. In other words, income from sales in the form of the cost of services rendered is recognized in accounting at the time of receipt of funds in their payment.
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