Cash vs. Accrual Reporting: Which is Right for Your Business?
Timothy J. Bubar, CPA
Thursday, October 18, 2018
Small businesses often use the cash-basis method of accounting. As businesses grow, they usually convert to accrual-basis reporting for federal tax purposes and to conform with U.S. Generally Accepted Accounting Principles (GAAP).
Starting this tax year, the Tax Cuts and Jobs Act (TCJA) has increased the threshold for businesses that qualify for the simpler cash method for federal tax purposes.
Companies that use the cash-basis method of accounting recognize revenue as customers pay invoices and expenses as they pay bills. So, cash-basis entities often report large fluctuations in profits from period to period, especially if they’re engaged in long-term projects. This can make it hard to benchmark a company’s performance from year to year — or against other entities that use the accrual method.
Cash-basis entities also tend to postpone revenue recognition and accelerate expense payments at year end. This strategy can temporarily defer the company’s tax liability. But the flipside is that it can make a company appear less profitable to lenders and investors.
The more complex accrual-basis accounting method conforms to the matching principle under GAAP. That is, revenue (and expenses) are “matched” to the periods in which they’re earned (or incurred).
Accrual-basis entities report several asset and liability accounts that are generally absent on a cash-basis balance sheet. Examples include prepaid expenses, accounts receivable, accounts payable, work in progress, accrued expenses and deferred taxes.
Under the TCJA, for tax years beginning after 2017, businesses with average annual gross receipts of $25 million or less for the previous three tax years are eligible for the cash method of accounting for federal income tax purposes. Under prior law, the gross-receipts threshold for the cash method was only $5 million.
Contact Tim to discuss the pros and cons of these two options to ensure you’re using the optimal method based on your circumstances.
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Tim has a combined 24 years of experience in public accounting and as CFO and CEO for a commercial business. He has extensive experience in the areas of accounting and consulting services including design of accounting policies and procedures and systems implementation. He performs a majority of the Firm's outsourced auditing and accounting services. His outside experience as a CFO and CEO brings unique insight and value to family businesses.