Please note: I am not a tax advisor, and this article is not tax advice. If you have any concerns around your recordkeeping method, ask your tax professional. Once you are ready to set up your accounting software, call or email us.
One of the first items of business that a new organization is left having to decide on is the decision to be cash or accrual basis when accounting for reporting and tax purposes. What are the differences?
If your business is accrual-based, you would recognize income and expenses when they are earned or used.
If your business is cash-based, you would recognize income and expenses when you get paid, or when you pay them (when the cash changes hands).
There are some nuances around this, and if you really dig into it, there are other methods as well, such as cash-modified basis. For the purposes of this post, however, I am going to focus on the basic accounting methods.
The methodology around keeping records for your business is not just a QuickBooks preference. It actually is referred to in IRS Publication 583. For convenience, I’ve included the link here. You will have to elect a reporting method when setting up QuickBooks, and formally when filing your first return with the IRS. I have had to switch accounting methods for a business before. It involves notifying the IRS, and filing a reconciliation return. Many fast-growing small businesses may one day have to do this.
If you have inventory on hand, generally speaking, you are required to keep accrual based books. Additionally, if your business revenue exceeds a certain threshold and you are not an S Corp, you may also have to be accrual based (per Publication 538, over $25M in revenue over the previous 5 years).
You can toggle between reporting methods in QuickBooks, but depending on what method you choose, you will almost certainly have journal entries based on your true method. Journal entries are posted based on the date of the entry, no matter what. Taking this into account, you may get a general idea of your reports by toggling between methods, but any accrual journal entries, adjustments, etc, that were made via journal entry will always post to the date of the journal entry. There will surely be other adjustments as well, so at the end of the day it is important to be clear on the method that you are accounting in, and to use consistent reports with the method you have chosen.
To further build on the issue, there are companies who will run management reports in an accrual method, and adjust to cash basis at year end. I, personally, find that, while possible and possibly applicable in some situations, this adds a little too much work, and believe that whatever method you report in should be the method you translate your business in.
Cash and accrual based accounting methods are very different and can change the picture you show a bank for loan purposes, investors, and the like. It is important to know how these methods affect your business reporting, and to discuss them with your tax pro prior to jumping into QuickBooks. If you are using QuickBooks already, and set it up in the wrong method, we or your accountant can help.
Questions? Let us know.