Are the credit notes subtracted from my total years sales even though I never returned cash to the customer?

[sayhi2angela]

I have a publishing company. I invoice customers for future services (a year of publications) and customers are on a monthly payment plan to pay off their invoice.  I decided to close the business so I applied credit notes to customers with outstanding invoices (for future publications they would not receive). Are the dollar amounts of the credit notes subtracted from my total years sales revenue even though I never returned cash to the customer? 

[MichaelMc · Accepted solution]

The answer to your question will depend on whether you have been using the cash method or the accrual method of reporting your business income for tax purposes. 

Cash method: You recognize income only as your customers actually pay you, and recognize expenses only when you actually pay for the purchase (whether by cash, check, credit card, or with borrowed funds).

Accrual method: You recognize income when you issue an invoice, even though your customers will not pay you until sometime in the future, and you recognize expenses when you purchase goods or services, even if you will pay for them in the future.

If you have been using the cash method, the "credits" issued to close out customer's invoices for publications they will not receive in the future will have no effect on the last tax year of your business. There is no "write-off" because you were never taxed on the as-yet unreceived income.

If you have been using the accrual method, you should write-off the value of the credits as "sales returns and allowances" because you had already recognized and been taxed on the income from the unsold publications.