There are two main forms of accounting, cash and accrual, and the type you use depends on your business. In general, most small businesses use cash accounting while large corporations use accrual. A new proposal in the Senate could require accrual accounting for a number of new businesses, and it faces strong opposition: 46 out of 100 US Senators have signed a letter opposing the proposal. Although it exists to, in theory, simplify the US tax code, it appears that the proposal could complicate things for many.
Types of Accounting
In cash accounting, receipts are recorded in the period they are received, and expenses are recorded in the period they are paid. In other words, the accounting method is in line with when cash actually changes hands, not when the commitment to pay is made. It is a clear, simple method of accounting favored by most small businesses.
In accrual accounting, expenses and revenue are recorded when they are incurred, not when they are paid. For example, a business would record income when it issued an invoice, even if that invoice was not collected until after the period. This allows a business owner to manage its total income and expenses in the period in which it is earned/incurred.
At the moment, there are a number of business types that are eligible to use the cash accounting method. These include:
- Professional services corporations
- Most farming and ranching businesses without inventory
- C corporations with less than $5 million in average annual gross receipts
- S corporations
Currently, a proposal has been put to the Senate that would require any business exceeding $10 million in annual gross receipts to use the accrual method. The concern is that converting to a new method of accounting could be costly and complicated for many businesses, as well as catapulting them into a potentially difficult tax situation. Businesses could then face a tax liability for income they hadn’t yet received and therefore may not be able to pay taxes on.
The change to the tax code could result in $23 billion in tax revenue over the next ten years, but it could come at the expense of small businesses who have to take out loans to meet their obligations.
The result of the proposed initiative remains to be seen, though if passed, could affect a large number of businesses. Both methods have their pros and cons, and whatever method you use should be carefully monitored to ensure the most accurate accounting possible.