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ProAdvisor

Re: Does Your Business Use Cash or Accrual Method Accounting?

I was looking at it as a customer deposit as opposed to deferred revenue. If the work isn’t performed, you owe the money back.

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Ok on deposits.  Don't have any of those.  Thanks

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Re: Does Your Business Use Cash or Accrual Method Accounting?

@Raywhite28, I really appreciate you bringing citations into this conversation. The small details like "non-refundable" as technical terminology matter, a key piece of insight for new business owners. 

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Re: Does Your Business Use Cash or Accrual Method Accounting?

@JMI-Bill, good points. Do you have a choice in your industry?

 

Also, cash is typically easier to manage for new owners, especially if they aren't doing any A/P, A/R. 

ProAdvisor

Re: Does Your Business Use Cash or Accrual Method Accounting?

You're welcome.

 

How I read it all was, just because your cash basis doesn't make all receipt a

income.

Community Host

Re: Does Your Business Use Cash or Accrual Method Accounting?

@Teri,

 

I love your insight and that you're the biggest advocate for accrual on the thread. Based on your experience, and to put the adage to the test, is accrual method noticeably more difficult to learn for new business owners? Or, is it perhaps that people get used to one method and find breaking the habit confusing? 

 

Those who are fresh and without preference may not have the barrier of assuming one is more difficult to manage than the other. 

Community Host

Re: Does Your Business Use Cash or Accrual Method Accounting?

@Raywhite28, thoughts on Schlude vs. Comissioner (1963)?

 

Other citation: Justia: Schlude vs. Commissioner of Internal Revenue. Appreciate the spirited analysis. 

ProAdvisor

Re: Does Your Business Use Cash or Accrual Method Accounting?

After reading through some of the case. The decision rested on the following:

the contracts did not provide for lessons on fixed dates after the taxable year. Instead, the lessons were to be arranged from time to time by the instructor and his student. Therefore, the student could arrange for some or all of the additional lessons or could simply allow their rights to lapse.

 

It was open ended.  It's wasn't like it was a monthly thing. It was when ever the student & instructor wanted. The contract may not have said anything about a refund of unused lessons either.

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Since GAAP accrual-basis accounting is required for all Govt contractors, and all of my clients are Govt contractors they have no other option than to learn it or pay me to do it and I discourage the latter. Best bet is for them to let me train them and then review their work.  Yes, I would say it is easier to learn accrual accounting when you have done none before, but since I teach it all the time, it is plenty easy to learn since I teach non-accountants to do it every day.

Community Host

Re: Does Your Business Use Cash or Accrual Method Accounting?

@Teri, I had several friends who worked for the A/P department at UCLA. It wasn't run all that efficiently... they should have come to you for a lesson. 

 

I wonder where "accrual is more difficult" mindset comes from. 

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Accrual is a foreign word to most outside of accounting.  Many have heard it but don't really know what it means, except they associate with accounting, which is a bad word to many. Same reason I think QB hides the words debit and credit, which makes me crazy.  Accrual is easiest to explain with regard to PTO accrual, since most people know what that is, since it hours you EARN over time to take vacation, and we all like that.  So you might accrue 80 hours per year or 120, point is you only ACCRUE a portion of that each month, 1/12th of it.

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Haha, on the A/P at UCLA, probably a large operation I would assume. A/P is entry-level accounting, where I started in 1985, best way to get your foot in the door, but experience can make you so much more efficient once you know the ropes, then you can move up.  A/P is exactly where you do the most accrual accounting, but often have no idea what that even means, I know I did not.  When I learned, using new fangled computer system, I never even knew there was another side to the entries I was making, I just input a bunch of invoices so the system did the other side of entry for me to the AP (accrual) account, to be paid later.

Community Host

Re: Does Your Business Use Cash or Accrual Method Accounting?

@Teri, I hear you!

 

When I first started learning the software, I was totally confused when members in the community used formal accounting terms.

 

From what I'm told here on campus, while terms like debit and credit are part of everyone's daily lexicon, the common perception of those terms can lead to confusion. Most people don't realize whom is being credited when using a credit card or what is being debited using a debit card. To avoid confusion for those outside the accounting profession, the terms were modified. 

 

All decisions made long ago. 

 

Curious what your thoughts are on when and how to introduce formal accounting terms. 

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Let's not forget, if we use QuickBooks, even if we report as cash or hybrid, we are using an accrual based software.

 

If we enter Vendor bills or invoice our customers - that is accrual. Pure cash basis eschews bills and invoices , they are disallowed by definition.

 

Payroll accrues liabilities. Taxes are always due after earned. But paychecks themselves are a cash basis record, as defined by the IRS. When I run payroll on 7/1 I cannot record that as having happened the day before. Conversely when i run payroll on 6/29 i have an expense for full gross wage and a bill essentially for my company share on 6/29 with a due date in July.

 

I get to use the IRS approved hybrid method of my choice as long as I am consistent. Expenses only occur when my vendors get paid but I claim all income in hand regardless of invoice date.

 

Should I not report all constructive receipts as income per pure accrual and avoid tax? 

 

My CPA supports moving prepaid rent to rent income

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Unfortunately, banking is what confuses many people from the start, because people are told their account will be "credited" for something when money goes into their account.

Which is exact opposite on your books because the bank is referring to their own books.

Cash accounts on your books (which only QB calls "Bank") should have a Debit balance.      If you have a Credit balance in your cash account you are overdrawn.  The bank is actually referring to their own books, they will book a credit on their books when they give you money. The bank does not know nor care what you do on your books, but you are going to Debit your Cash account when money comes in and Credit Cash when money goes out. I emphasize the part in bold since if you think about that it makes sense, they don't care.

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Unfortunately, banking is what confuses many people from the start, because people are told their account will be "credited" for something when money goes into their account.

Which is exact opposite on your books because the bank is referring to their own books.

Cash accounts on your books (which only QB calls "Bank") should have a Debit balance.    If you have a Credit balance in your cash account you are overdrawn.  The bank is actually referring to their own books, they will book a credit on their books when they give you money. The bank does not know nor care what you do on your books, but you are going to Debit your Cash account when money comes in and Credit Cash when money goes out. I emphasize the part in bold since if you think about it that makes sense, they don't care.

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Hi John - 

Not sure I agree or maybe I do not fully understand what you mean when you say that we are using "accrual-based" software, and please spare me the accounting lesson since I've done accounting for almost 40 years on accrual-basis, but I am not trying to offend you.  I think we chatted before since I recall your name and pretty sure we agreed on all things, so I already know you are a smart guy so maybe I am totally missing your point here, but

 

"Accrual-basis" accounting has nothing to do with the SW itself other than it being able to handle the required input and output. You can input invoices to QB and pay them using the Cash account vs. AP account, and then you are doing Cash-basis accounting.  You could also pay your employees using greenbacks and record all in QB on Cash-basis, since you could hand-carry your payroll taxes to local agencies or write checks when you pay payroll, or even just record all payroll amounts on the day you pay the cash out too, and that would also be cash-basis accounting, so you have the option of either here.    

 

As a separate fact or topic, yes, individuals who receive paychecks W-2's or 1099's are always Cash-basis for taxes, regardless of what method your company uses for taxes or for their accounting. Totally separate matter.  So whenever your company accrues or pays payroll,  the answer is the same for individuals, their paycheck and W-2 will always only counts the cash paid to them on or before 12/31, all else counts as next year's pay.  

 

Accrued payroll arises when for example in my industry where we are required to do accrual-basis accounting and are also required to do Timesheets, where each day of a semi-monthly (my period preference) timesheet period, say June 16-30, we accrue the labor expense based on employee hours on timesheets (system does automatically). Then on June 30, we have a half month of labor expense accrued, that we all call "accrued payroll" (debits in labor expense accounts and credit in accrued payroll or payroll payable as I often call it), which is a liability to pay employees for that payroll. 

 

Then we process payroll which computes gross to net pay and it creates additional 

liabilities for payroll taxes.  Some from employee gross pay and some new expense for employer-paid portion.   Then when cash is paid out to employees and tax agencies,  assuming we previously accrued the labor expense and maybe the payroll taxes too,

we debit the liabilities to clear accrued payroll and payroll taxes if also accrued, and credit cash account.  That is the company doing their payroll on an "accrual-basis" as 

part of their accrual-basis accounting practice (before we ever discuss IRS or taxes).     

 

Separate and regardless of that, the company may do taxes on cash or accrual-basis, where accrual would be same as done on books, but cash-basis company taxes would just coincidentally be same as for employees, where cash paid 12/31 or earlier counts

in current year and anything paid after 12/31 is part of next year's taxable income or expense on W-2, 1099, 1040, 1120s or whatever tax form is applicable for the entity. 

 

Here is where there is commonly a hybrid that I do myself.  Technically, payroll taxes are due same day as payroll. So in my example of timesheet / payroll period ending 6/30,  where payroll is expensed and "payable" on 6/30, payroll taxes are also owed then too.  So as of 6/30, you have a liability for pay to employees and for EE and ER payroll taxes and to do correctly in addition to accruing labor from timesheets, you would estimate and accrue employer payroll taxes (since employee taxes are already part of gross pay). 

 

But IMHO, not worth it to estimate and accrue employer payroll taxes and to reverse them since you will not likely be able to estimate them exact to the penny unless you have already hit FICA, FUTA and SUI limits for the year and all employees are salaried.    So although I accrue labor which is gross pay so includes employee payroll taxes, I just usually expense the employer portion after payroll runs and we have the actual totals.  That is what I would do on QB Payroll anyway since you don't know taxes until payday.  

 

Most of my clients use Gusto Payroll where we can see all in advance so then we can accrue payroll from timesheets as required and record payroll taxes as computed by 

Gusto payroll in the current period to do full and proper accrual-basis accounting for payroll and we can even reconcile accrued payroll before payday, which is great so if there are any errors you can actually correct them before payroll is even paid out.  

 

Please advise if that does not make sense since I know it is correct but maybe confusing.  

 

With regard to AR and AP, pretty sure you must do same for both, either cash or accrual, where cash-basis records on the day you pay or recieve actual cash payment or accrual-basis which for AP is when good or services are received or used and AR may vary by contract type as to when it is earned, which is a whole separate topic of discussion, but in simplest terms is when you have done the work regardless of when paid by customer. 

 

I would definitely not do as you say in 3rd to last sentence, which is AP on cash basis and AR on accrual-basis, since that is not only inconsistent, but you get screwed on taxes as you will be paying taxes in advance on AR and deducting AP expenses a month behind, so giving way too much to the IRS every year end, paying them a year in advance really.

 

Your last sentence I do not understand at all since I don't know your business but prepaid rent is an expense like your own rent that you paid in advance, like Jan rent paid in Dec, where on accrual basis, you would expense in January but for cash-basis count in Dec.  Rental income tells me maybe you have renters who pay you rent in advance, where if they pay YOU for Jan rent in Dec, on cash-basis, I assume you must count in old year but if accrual basis, assume you book as a liability to deferred rent at year end and then can count as rental income taxable in the new year. But no expertise on rental income so be sure to get clarification on this last paragraph, since unlike the first 99, not sure on this. 

 

So now I am just typing to see how long I can actually write an answer here b4 cut-off.

Community Host

Re: Does Your Business Use Cash or Accrual Method Accounting?

@Teri@john-pero is a very smart and insightful guy, we very much value him bringing balance to every conversation. And @Teri brings much-needed expertise to the community. 

 

To @Teri's points, there's obvious complexity between the functions of QuickBooks as software (in which using bills or invoices creates A/R and A/P) and how income is, in the end, actually reported to the IRS.

 

Correct me if I am wrong, @john-pero, I can run my reports at the end of the year as cash or accrual, in which point those ending figures are what "my businesses uses as an accounting method?"

 

Or, is it that once I start using invoices and bills, I must file my taxes based on accrual method going forward and stay consistent with that reporting.

 

The power of QuickBooks is one's ability to get both insights, but I want to make a distinction (if needed) between capabilities/usage and the actual action of filing taxes.  

 

@Raywhite28 is also a big advocate of hybrid methods!

 

I'm really enjoying how the group is drawing out the complexity of such a simple question. 

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Re: Does Your Business Use Cash or Accrual Method Accounting?

James - I agree @john-pero has posted some great stuff that I have seen, so no worries.    I assume I disagreed with something he said based on your response without looking back and was several weeks ago. I can almost guarantee he knows more on QB functions than me so no issue there either.  Setting that aside, to let him respond on QB functions, I can respond on accounting and taxes in general for sure since it is the same regardless of accounting system functions.  I should limit to referring only to U.S. as that is all I know.

 

First, as we may have discussed earlier, accounting can be done on cash or accrual-basis and taxes can be done on cash or accrual basis and they do not have to be the same but there are some limitations as to which companies can use which method, for example, as mentioned in my industry of Govt contractors, accrual-basis accounting is required, but for taxes, you can choose cash or accrual-basis. 

 

I think accrual-basis is required for accounting AND taxes for all PUBLIC companies to make consistent for all of their SEC  filings where company financials are public and reviewed by investors on stock market, ie, John Q. Public, so that they are comparable to other public companies. 

 

I do know that you need to keep consistent from year to year on both accounting and taxes, whichever method you choose since otherwise you could make a mess of things on your books and could cheat on your taxes. You can change methods but that should be like a one-time change (usually from cash to accrual), never heard of anyone going backwards. 

 

I know you must show on tax return right on front page whether taxes are filed on cash or accrual basis and know there are adjustments you must make for that conversion and think there is a time limit on how long you would have to wait to switch methods for taxes, so you cannot just switch back and forth whenever you like...

 

ALL of that to say that I know you would NOT want to randomly decide based on how you run your reports on QB.  So the capability to run cash or accrual-basis reports is handy but can also be risky in the hands of anyone inexperienced with the requirements and the resulting ramifications.

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Re: Does Your Business Use Cash or Accrual Method Accounting?

 

Been out of touch a couple of weeks so let me jump back in feet first, lol

@JamesOng 

"Correct me if I am wrong, @john-pero, I can run my reports at the end of the year as cash or accrual, in which point those ending figures are what "my businesses uses as an accounting method?"

 

Or, is it that once I start using invoices and bills, I must file my taxes based on accrual method going forward and stay consistent with that reporting."

 

Yes, you can, and should, run year end reports in both formats, not just to see the differences but also there may be adjustments you have to make - like moving prepayments to income. Back to our own operations: a tenant pays for January rent in December. That is considered a pre-payment since there is no charge yet due on the books until 1/1. The IRS, somewhere in their rules, prohibits or at least severely frowns on you holding onto a check with 2017 date until a 2018 deposit - in cash accounting if it is in hand it is income. So, once a year, whether we have deposited or not, we make an entry clearing pre-payments into ordinary Rent income.

 

If we reported accrual, not only would we leave the prepayment as a liability, but would also be reporting income for all the back rent that has gone uncollected since under accrual, income is recorded when customer is billed (or service rendered). At some point under accrual I would have to determine when an account can no longer be collected from (like when we have locked them out) but under cash we can if we choose leave unpaid invoices on the books with no effect on income or taxes. We cannot inactivate a tenant until the unpaids are cleared but it can be as simple as deleting the invoices (hybrid-cash accounting) raher than posting to a doubtful account expense

 

In a true sense, if we allow a customer to pay later or our suppliers allow us to pay later, including payroll taxes, which depending on agency are not due on the date of payroll but due when the agency says. An example of this is FUTA which is never due and payable until the 15th of the first month following the quarter when you exceed $500 in FUTA liability. Another is if the feds determine you are a yearly filer (944 instead of 941) and you file quarterly and pay quarterly you get a somewhat nasty letter telling you not to pay ahead. And I though DC needed all the money it could get.

 

And, yes, in truest sense, once we use bills and invoices we technically are accrual, but have the choice of the hybrid method

 

Community Host

Re: Does Your Business Use Cash or Accrual Method Accounting?


@john-pero wrote:

 

 Back to our own operations: a tenant pays for January rent in December. That is considered a pre-payment since there is no charge yet due on the books until 1/1. The IRS, somewhere in their rules, prohibits or at least severely frowns on you holding onto a check with 2017 date until a 2018 deposit - in cash accounting if it is in hand it is income

 Thank you for this @john-pero. When I first learned about Cash v Accrual, the above was always cited as the demonstrative example - "if you hold onto a payment given in December but deposited in January..."

 

Now I know, concept aside, the actual practice is frowned upon. Certainly seems like an easy Red Flag. This last January, we had several posts about rolling income (or rather, what counted as income). This will be very valuable for community members going forward. You could write a book, John...

 

Are there actual guidelines to the Hybrid Method, or is it loosely defined? 

Community Host

Re: Does Your Business Use Cash or Accrual Method Accounting?

@Teri, and we know you've posted excellent content as well! 

 

"First, as we may have discussed earlier, accounting can be done on cash or accrual-basis and taxes can be done on cash or accrual basis and they do not have to be the same but there are some limitations as to which companies can use which method, for example, as mentioned in my industry of Govt contractors, accrual-basis accounting is required, but for taxes, you can choose cash or accrual-basis."

The point you raise is fundamental to the conversation. The challenge is knowing when which rule applies, to whom, and why. Laws are complicated. I am happy to see you sharing your knowledge and making people be aware of the complexity. I am sure the IRS has a complicated list we could reference.

 

Does anyone else know off-hand of other industries that are required to follow a particular method?

  

"I do know that you need to keep consistent from year to year on both accounting and taxes, whichever method you choose since otherwise you could make a mess of things on your books and could cheat on your taxes. You can change methods but that should be like a one-time change (usually from cash to accrual), never heard of anyone going backwards."

 

It's possible to switch but it's very complicated and, as you mentioned, can make a real mess of things. It's definitely something you need to do with the help of a pro. You can't change things on a whim! Take note, readers. 

 

"ALL of that to say that I know you would NOT want to randomly decide based on how you run your reports on QB.  So the capability to run cash or accrual-basis reports is handy but can also be risky in the hands of anyone inexperienced with the requirements and the resulting ramifications."

 

I think this is the challenge of using a powerful program. @mrider brought up a really interesting conversation a while back that centered around "can vs. should." You can do a lot in QuickBooks. You can write all kinds of numbers and run reports in a million different ways. We want users and community members to be informed and make smart decisions - - that's where the guidance in this conversation has real value. 

 

You're absolutely right to say, @Teri, that people decide based on a holistic view/the needs of their business. QuickBooks runs on accrual, there's no way around that, but that doesn't mean people are forced to only report accrual - they can do the hybrid method. 

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Re: Does Your Business Use Cash or Accrual Method Accounting?

Thanks for reading my post and it seems like you are following so that is great and hope is helpful to others.  Wanted to clarify on your last statement since I have seen said before:

 

Two things and totally separate matters, you said:

"QuickBooks runs on accrual, there's no way around that, but that doesn't mean people are forced to only report accrual - they can do the hybrid method." 

 

1)  "QB runs on accrual", no such thing.  No system can run on accrual-basis by itself.

Accrual-basis accounting REQUIRES ENTRIES MADE ON SPECIFIC DATES, for example, inputting vendor bill for March in March vs. April when it is paid  (true QB/any system). 

 

1a) "QB allows you to run a report to include that invoice on accrual-basis, or to exclude it if you run same report on cash-basis.  That is all that QB system can possibly do for you.  This shows you the difference between accrual and cash-basis on the same report.  

 

1b) If that same invoice for March is input when paid in April, reports are the same.

Running report on accrual-basis means nothing if entries are not input on accrual- basis. 

 

Anyone agree or disagree?

 

 

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Re: Does Your Business Use Cash or Accrual Method Accounting?

I am late to this party, but I agree with Teri.  I never understood how you could run a business with financial reports presented on a Cash basis.  Cash is King for almost any business.  Management and Board members need to know who owes you money and to whom your business owes money - how much and when it is due, and how much is past due.  For businesses I ran, I required that an accounts receivable aging report be on my desk every Monday morning, and the same for payables.

 

These reports do not exist for financial statements prepared on Cash basis.  Fortunately, QBO give you the option to run most report on either an accrual or cash basis.

ProAdvisor

Re: Does Your Business Use Cash or Accrual Method Accounting?

Other Accounting packages that I have worked with provided reports for both receivables & payables regardless if the financials are on cash or accrual basis.

 

on cash basis, those accounts should not appear on the balance sheet.