Pros and Cons of Accrual

Even if your business does not have inventory, if you have a lot of complex transactions during the year you may find the accrual method more desirable, because expenses are deducted in the year in which the income to which they relate is reported. By using the accrual method, your net income tends to be leveled out, avoiding income peaks that are subject to higher tax rates.

For some business owners, the accrual method does not necessarily reduce taxes, and may create many unnecessary accounting headaches when compared with the cash method. On the other hand, most accountants feel that the accrual method is the only one that accurately reflects the true financial state of your business.

In selecting the most appropriate accounting method, there's one disadvantage of the accrual method that tax planners like to emphasize — it is more difficult to minimize taxes by shifting items of income and expense from one year to another under the accrual method. The cash-method business owner may be able to collect fees, rents, interest, and other obligations in advance or put off payment until a later year. The cash-method owner can also usually control expenses to some extent by accelerating or deferring payment for items such as advertising, supplies, repairs, interest and taxes.

Controlling income and expenses is not nearly as easy for the accrual-method business owner. He or she can defer some income into the next tax year by shipping and invoicing as little as possible during the closing days of the year, but this may not be worth the cash-flow problem that it may cause. Or the owner can try to accelerate expenses by requesting the delivery and billing of supplies before the end of the year.

With the accrual method, income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands. An excellent example is a sale on credit. The sale is entered into the books when the invoice is generated rather than when the cash is collected. Likewise, an expense occurs when materials are ordered or when an employee has logged in a workday, not when the check is actually written. The downside of this method is that you pay income taxes on revenue before you’ve actually received it.


RESOURCES:

WWW.BUSINESSTAXRECOVERY.COM
WWW.WEB-SERVICES.GOV
WWW.IRS.GOV
WWW.ENTREPRENEUR.COM