There are two accounting methods, cash and accrual. Most small businesses use the cash method.
Cash
Under the cash
method, include in your gross income all items of income you actually or
constructively received during the tax year. Items of income include money
received as well as property or services received.
Constructive
receipt. Income is constructively received when an amount is credited to your
account or made available to you without restriction. You do not need to have
possession of the income for it to be treated as income for the tax year.
Accrual
Under an accrual
method of accounting, you generally report income in the year earned and deduct
or capitalize expenses in the year incurred.
*The cash method of accounting is focused on the
inflows and outflows of cash. Much like your personal finances, organizations
have revenue when we make a deposit and incur an expense when we cut a check.
There is little regard to when the revenue was actually earned or the expense
was actually incurred, we just worry about the cash flows.
The accrual method of accounting doesn't worry about
cash flow and instead focuses on when revenue was actually earned and when
expenses where actually incurred. For example, let's say you purchase office
supplies in the month of April on your credit card and pay for the purchase in
May when you receive the credit card bill. Under the accrual method of
accounting we would record the expense for supplies in April.
*The main difference between accrual and cash basis
accounting is the timing of when revenue and expenses are recognized. The cash
method is most used by small businesses and for personal finances. The cash
method accounts for revenue only when the money is received and for expenses
only when the money is paid out. On the other hand, the accrual method accounts
for revenue when it is earned and expenses goods and services when they are
incurred. The revenue is recorded even if cash has not been received or if
expenses have been incurred but no cash has been paid. Accrual accounting is
the most common method used by businesses.
