Accrual Accounting and Cash Basis
Under the accrual accounting system, revenues are recognized when collected, and expenditures are identified in the same timeframe as the associated income. According to the cash basis of accounting, revenues are acknowledged when cash is earned, and costs are realized when paid. I do not think Bob should use the cash basis of accounting because he wants to start an operated car company. Closing a single-car sale is difficult because of the huge number of deals, approximately 30 deals in a month. Using the cash basis of accounting will make it very difficult to keep track of all the aspects of each sale. For example, car registration fees, and receivables from authorized car loans from diverse lenders, payable sales tax, and down payments. Provided Bob uses the cash basis for his accounting system rather than the accrual method, he will end up recording lower sales, consequently, lower net profits at the end of the year. Many individuals assume that by using this form, they can save money on taxes, but the income will only be deferred until the following year (Nitzl et al., 2020). As a result, the revenue from current-year revenues will ultimately be listed on the tax return on income.
Description of When Revenue Would Be Recognized on the Sale Inventory Based on the Decision of Accrual vs. Cash Basis
Premised on the details we discussed above, I would recommend the accrual method of accounting as the best choice for Bob’s company. The income will be recorded using the accrual method of accounting when the inventory is delivered, not when the payment is made. The taxpayer must include all products of money earned in gross income and exclude expenditures in the tax year in which it was charged under the cash method. However, if an inventory is required to account for profits, the sales and transactions must be recorded using the accrual system.
Even if they manufacture, buy, or sell goods, the following taxpayers will benefit from using the cash form of accounting:
A taxpayer who meets the following criteria:
- Annual gross receipts of $1 million or less for each previous tax year.
- A company is not a tax haven.
A small business taxpayer who meets the following criteria:
- Annual gross receipts of more than $1 million but less than $10 million for each previous tax year.
- Are forbidden from using the cash form under Internal Revenue Code Section 448.
- The primary source of income is a qualifying company.
According to the accrual accounting system, income is recorded in the year paid, and expenditures are deducted or capitalized in the year they are incurred. This method of accounting is used to ensure that revenue and expenses are recorded in the correct year. There is also the technique of combining forms (Schmidthuber et al., 2020). The plan indicates income and expenditures and is used consistently based on any currency, special, and accrual accounting methods. The following limits, however, apply:
- An inventory is required to account for revenue, and the accrual approach must be used for purchases and sales. All other sources of income and expenditures may be accounted for using the cash process.
- If one uses the accrual method to record your spending, you must still use the accrual method to figure your revenue.
- If the cash method is used to calculate revenue, the cash method must also be used to report expenditures.
- If a cash method is used as part of a combination method, the combination method must be considered a cash method.
Determination of the Economic Impact on the Client’s Financial Situation and the Potential Tax Liability, Based on Appropriate IRS Code and Regulations
Bob’s new company will benefit from using the accrual form of accounting since it helps the company keep closer records of all payments. It also enables the company to better view its success by comparing profits and associated expenditures over time to see how well or poorly they are doing (Triyanto, 2019). This ensures that all transactions relating to this company’s start-up must be disclosed on the tax return. All expenditures determined to be due during the year, even if not yet charged, as well as all income determined to be earned but not yet paid, should be deductible in the income tax return.
Summary of Cash Flow or Accrual Accounting Method Based on the Selected Business Entity
Suppose Bob’s company uses the cash basis of accounting, and he reports his income tax return using the accrual method. In that case, he must convert his cash basis accounting to the accrual method by accumulating all due invoices and expected expenditures for the year to be filed to comply with the IRS Code. Bob would still have to record all of the completed transactions’ profits, even though the money has not yet been paid. If Bob, on the other hand, uses the accrual form of accounting for his day-to-day business and this income tax return, no financial statement changes would be required to comply with the IRS Code.
References
Nitzl, C., Hilgers, D., Hirsch, B., & Lindermüller, D. (2020). The influence of the organizational structure, environment, and resource provision on the use of accrual accounting in municipalities. Schmalenbach Business Review, 72(1), 271-298. Web.
Schmidthuber, L., Hilgers, D., & Hofmann, S. (2020). International public sector accounting standards (IPSASs): A systematic literature review and future research agenda. Financial Accountability & Management. Web.
Triyanto, D. (2019). Fraudulence Financial Statements Analysis using Pentagon Fraud Approach. Journal of Accounting Auditing and Business, 2(2), 1-7. Web.