In this article, we'll help you identify which method of accounting you use in your tax return.
If you've already filed a tax return in the past: you already chose cash or accrual on your past tax return. In this article, we'll show you exactly where you can find this info.
If it's your first year in business and haven't yet filed a tax return: Skip to DEEPER DIVE INTO THE TWO METHODS below to read about the pros and cons of each and choose the best option for your brand.
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Cash or accrual accounting? This is a conundrum that has plagued business owners since the dawn of time (or at least since the early 1900s when accrual became a thing).
How do I know which one I use? What are the real differences between the two? Which one makes more sense for my business? All good questions. Lucky for you, we have the answers.
How do you know which I use for my business?
You can find this information on your tax return. Find your entity type below with the exact instructions on where to look. If you're looking for more details on understanding the differences between the two methods, just scroll down.
Form 1120 (U.S. Corporation Tax Return)
Page 4, Schedule K, Question 1
Form 1120-S (U.S. Income Tax Return for an S Corporation)
Page 2, Schedule B, Question 1
Form 1065 (U.S. Return of Partnership Income)
Page 1, Question H
Schedule C (Profit or Loss from Business filed with your personal tax return)
Page 1, Question F
DEEPER DIVE INTO THE TWO METHODS
What is the difference between cash and accrual methods of accounting?
It all comes down to timing.
Cash basis accounting - you recognize income when the cash is received and not when earned and you recognize expenses when the business pays, not when incurred.
Accrual basis accounting - you recognize income when earned and you recognize expenses when incurred.
Essentially, one of the main differences between the two is whether you recognize accounts receivable (sales you made / invoices you sent out but for which you still haven't received the payment) or accounts payable (bills you received from vendors but still haven't paid).
For example:
You sell a product through a wholesale channel on Feb 1 and receive the payment on March 1. You receive a vendor invoice on April 1 and pay the vendor on May 1.
| Cash | Accrual |
Income recognition | March 1 | Feb 1 |
Expense recognition | May 1 | April 1 |
Which one makes the most sense for your business?
Sorry, I hate to be "that guy" but the real answer is, it depends. There are pluses and minuses to both:
Cash
Pros - Simple to maintain, helps you track cash flow
Cons - Doesn't give you visibility into the real financial health of your business
Accrual
Pros - Gives you better visibility into the real financial health of your business
Cons - More complex to maintain, no real cash flow management
The good news is, once your business earns, on average, more than $25 million in gross receipts over the previous 3 years, the IRS takes this decision out of your hands and requires you to choose accrual. Well, ok maybe it's not quite good news but at least you no longer have to decide. Right?