Advantages of Accrual Accounting

It can be summed up in two phrases: Accrual accounting offers greater flexibility.

Accrual accounting provides a better matching of costs and revenues, resulting in a more meaningful financial statement. Let's assume that, as the year is ending, a business ally is planning a new venture and wants to tap the expertise of your company's marketers. That firm contracts with your marketers to consult during the following year and makes a sizable advance payment on the upcoming consultation fees just before the holidays. In what year is that income for the marketing department taxable? According to the IRS, your company will need to pay taxes on that advance payment only when the marketers are actually doing the work. In other words, since the payment is for consultation scheduled for the new year, the marketers are not providing any value in exchange for that payment until they begin working.

Thus, your company pays taxes on that income as the work is being done. That type of value recognition and flexibility is one of the advantages of accrual accounting.

On the other hand, that business ally would be deducting the advance payment as an expense in the year in which it made the payment, even though the marketers had not yet started consulting. There are exemptions for recurring expenses, and your company specialist will want to consult fully with your tax advisors or attorney on this matter. Those cold, hard facts of taxes may cause some businesses to engage in a flurry of deals in December. And you thought it was just the holiday spirit… Now, let's put those talented marketers in another situation. Assume they started providing consulting services for that business ally during the old year, but their services will not actually bring income into your company until the new year, after they've finished their consulting.

At that time your company will receive compensation in full for those marketing services. Although your company did not receive any payment until the new year, it must report that part of the income earned by the marketing services provided during the old year. Again, you don't need to know all the ins and outs.

But you should certainly understand the basic principles involved, so you can appreciate the timing involved in business conducted around the end of the tax year.

Below are partner sites:

If your company is reporting on a cash basis and wants to change over to an accrual basis, the IRS will allow that change, provided you file Form 3115 within 180 days of the beginning of the tax year, whether or not the company's fiscal year mirrors the calendar year.

The $10,000 Business Cash Question Most successful business owners are not criminals, but easily could become criminals if they're not aware of reporting requirements and restrictions for cash receipts of more than $10,000. For amounts this size, businesses must complete IRS Form 8300. That form is used largely to help track criminal activities, particularly drug trafficking and money “laundering.” The IRS requires that Form 8300 be filed within 15 days of such a transaction.

Also note that none of the fee can be deferred or split into smaller payments in order to avoid completing the form. Uncle Sam will assume your firm has something to hide and, if he finds out, will pursue it with a vengeance. Failing to file because your tax specialist forgot or didn't know can cost the company $50 for each instance, although, based on circumstances, the penalty can be rescinded at the judge's discretion.

For businesses that fall below the $5 million ceiling, those fines can't exceed $100,000 per year. Businesses over $5 million can pay up to $250,000. Ignorance and a faulty memory can be very expensive! However, if the IRS determines the failure to file Form 8300 was intentional, then the penalty is either the amount in question or $25,000, whichever is greater.

What's more, criminal penalties apply. That, after all, is how the feds nailed Al Capone. Filing Schedule C Taxes Large-scale corporate tax preparation is beyond the scope of this chapter and the intent of this book. (After all, if you're involved in such preparation, it's likely you're not a complete idiot about finances.)

But if you're involved in an entrepreneurial business, it may be helpful to know about Schedule C. Schedule C-EZ is not an option for many entrepreneurs, but if your business operates with an expense level of $2,500 or less, then you qualify.

However, your company can't carry inventory nor claim a home office expense. A single individual must be sole proprietor, with no employees, no prior-year suspended activity losses, and no depreciation. That's quite a lot of limitations, but there are people and businesses who qualify. Executives who also earn money from consulting or professional speaking fall into this category. The form also is perfect for full-time sales persons and commission drivers, employees who derive their primary income from this activity.