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The cash method of accounting, also known as cash-basis accounting, cash receipts and disbursements method of accounting or cash accounting (the EU VAT directive
vocabulary A vocabulary is a set of familiar words In linguistics Linguistics is the scientific study of language A language is a structured system of communication used by humans, including speech (spoken language), gestures (Signed la ...
Article 226) records revenue when cash is received, and expenses when they are paid in cash. As a
basis of accounting A basis of accounting is the time various financial transactions are recorded. The cash basis (EU VAT vocabulary ''cash accounting'') and the accrual basis are the two primary methods of tracking income and expenses in accounting. Both can be ...
, this is in contrast to the alternative
accrual Accrual (''accumulation'') of something is, in finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments ...
method which records income items when they are ''earned'' and records deductions when expenses are ''incurred'' regardless of the flow of cash.


Cash method of accounting in the United States (GAAP)


Use in contract accounting

The cash method of accounting has historically been one of the four methods of recognizing revenues and profits on contracts, the other ones being the
accrual method A basis of accounting is the time various financial transactions are recorded. The Cash method of accounting, cash basis (EU VAT vocabulary ''cash accounting'') and the accruals, accrual basis are the two primary methods of tracking income and exp ...
, the
completed-contract methodThe Completed-contract method is an accounting method of work-in-progress evaluation, for recording long-term contracts. Generally accepted accounting principles, GAAP allows another method of revenue recognition for long-term construction contracts, ...
and the
percentage-of-completion method Percentage of completion (PoC) is an accounting method of work-in-progress evaluation, for recording long-term contracts. Generally accepted accounting principles, GAAP allows another method of revenue recognition for long-term construction contract ...
s. Since the approval by Congress of the
Tax Reform Act of 1986 The Tax Reform Act of 1986 (TRA) was passed by the 99th United States Congress and signed into law by President Ronald Reagan on October 22, 1986. The Tax Reform Act of 1986 was the top domestic priority of President Reagan's second term. The ac ...
, the cash method could not longer be used for
C corporation A C corporation, under United States federal income tax law, is any corporation A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by pri ...
s, partnerships in which one or more partners are C Corporations,
tax shelter Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. The methodology can vary depending on local and international taxation, internatio ...
s, and certain types of trusts. Because of 1986 regulation, in general, construction businesses do not use the cash method of accounting. Some construction businesses use the cash method; and there are many other companies that use a modified form of the cash method, which is acceptable under federal income-tax regulations. Under the modified Cash method of accounting, most income and expenses are determined under cash receipts and disbursements, but purchase of equipment and of items whose benefit will cover more than one year is to be capitalized, whereas such items as depreciation and amortization are charged to cost.


Use in other types of businesses

The cash method of accounting is also used by other types of businesses, such as farming businesses, qualified personal business corporations and entities with average gross receipts of $5,000,000 or less for the last three fiscal years.


Advantages for tax planning and IRS stand

There are certain advantages in
tax planning Tax avoidance is the legal usage of the tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law Law is a system A system is a group of Interaction, inte ...
when the cash method of accounting is used: for instance, payment of business expenses may be accelerated before year end, in order to maximize
tax deduction Tax deduction is a reduction of income that is able to be tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law Law is a system A system is a group of ...

tax deduction
s, whereas billings for services may be postponed to after year end, so that payments won't be received until the new year, thus postponing tax payments on such income. Because of these advantages and the manipulations that can occur with it in order to minimize taxable income, the
IRS The Internal Revenue Service (IRS) is the revenue service A revenue service, revenue agency or taxation authority is a government agency responsible for the intake of government revenue, including taxes and sometimes non-tax revenue. ...
has discouraged (although not prohibited entirely) the cash basis of accounting for tax purposes. For instance, companies that use the cash basis of accounting may not report any inventory in their financial statements, in fact reporting of any inventory at year end can lead to manipulation of taxable income to an enormous extent.


Cash method of accounting according to IFRS

While the standard accounting methods commonly used in first world countries such as the United States are more than adequate for the appropriate times and eras dependent upon the incumbents of the agencies which patrol the financial statements and account balances of both mom and pop shops and multinational conglomerates, it is become increasingly obvious in more recent years that the international standard(s) of accounting found in IFRS and the field of
forensic accounting Forensic accounting, forensic accountancy or financial forensics is the specialty practice area of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about econ ...
itself benefit greatly due to the advantages found in the cash method of accounting according to IFRS. For example, "Imagine you purchase a car for $20,000 in 2015, but under a special promotion no payments are due on your bill until 2018. In what year did you incur the $20,000 bill? Most people would say 2015, the year you acquired the car. That’s the answer mandated under accrual accounting, a method of financial reporting required of all public companies by the Financial Accounting Standards Board. But many state and city legislatures disagree. They operate with the conviction that a bill is not incurred until the money leaves your bank account to pay it. So if you choose not to pay the bill for your car until 2018, for accounting purposes the bill will only appear that year."


References

{{reflist Accounting systems Cash