Archive for Accrual Accounting
November 19, 2008 at 5:21 am · Filed under Accrual Accounting
There are 2 types of tax accounting methods to use when submitting business figures to the Internal Revenue Service. These 2 methods are the cash and accrual methods. Choosing which method you use is determined by the company.
The decision can be as simple as a personal preference or many factors can play into the selection. Larger companies tend to have many factors like sale procedure, how many salesmen, volume of sales, number of sales, inventory, when the commission is paid, the percentage of operations are sales compared to production, accountant or business partner experiences, and the list goes on.
Accrual method of tax accounting records all sales and transactions at the time of the agreement. Even if the money does not exchange hands, according to the accounting record books, the sale is complete and accounted for.
This method takes discipline to make sure all payments are actually received. Since the books show the transaction as complete, a separate ledger must be kept to follow up with payment plans and collection. This can be especially difficult for small businesses that may not employ a secretary or accounting staff. With fewer numbers of sales, accrual accounting just means more work of entering sales and payments in two separate books.
If a company sells expensive products, partial payments on long payment plans are generally used. When using accrual accounting this can reflect the cash flow drastically different. If 3 items are sold in one month for $30,000 and next month 6 are sold for $60,000, it looks like twice the income. However, accrual accounting does not take the payment plans into account. Payment plans could range from 2 payments in 6 months to 24 payments over 2 years. Usually longer plans are needed for larger purchases which will show more inaccurate.
Let’s say a company just starts and has $30,000 in sales the first month, but each sale has a long-term payment plan. Only looking at accrual accounting would be misleading because only $3,000 was physically obtained. When you look to pay bills for operating expenses, accrual accounting will not show how much liquid finances you have to use.
After the tax accounting selection for the accrual method has been made it is difficult to change methods. If a change is absolutely necessary, there is a way. The last 2 consecutive years must have used the accrual method and the Secretary of the Treasury must receive a written request. The business owner should use a certified public accountant to help make sure this procedure is done correctly.
Joe Coffee is a consultant for the online marketing firm, Web Shepherd. Visit www.AccountingAndYou.com for tips about leading methods of accounting and tax accounting options.
Article Source: Tax Accounting Using the Accrual Method
http://bossadvice.com/2008/11/06/tax-accounting-using-the-accrual-method/
November 17, 2008 at 6:53 am · Filed under Accrual Accounting
Fancy buying the Taj Mahal or the Qutab Minar for Re 1? Well, that could be the price the government may assign to most heritage structures when it switches to a more transparent system of accounting its assets and liabilities over the next two-three years.
The government is finalising a road map to move to a system of “accrual-based accounting” from the current cash-based accounting system to better reflect the nation’s assets and liabilities in its annual financial statement. The new system is meant to capture some of the government’s liabilities and assets that now find no mention in the annual budget.
One key aspect of the proposed accrualbased accounting system is to include national assets through a process called “heritage accounting” . Under this system, historic monuments , museums and paintings will find mention in the government’s statement, but its treatment may be different from other commercial assets.
Since the cost of acquiring the Taj Mahal cannot be calculated, it cannot be ascribed a tangible value in the government’s books. Also, unlike other commercial assets, heritage assets will be difficult to depreciate given that they are cultural symbols for posterity. But since a value will have to be given regardless, the Taj Mahal may find itself with a Re 1 price tag in the government’s books.
http://economictimes.indiatimes.com/ET_Cetera/Buy_Taj_Mahal_amp_Qutub_Minar_at_Re_1/articleshow/
November 8, 2008 at 1:35 am · Filed under Accrual Accounting
The antipathy towards mark-to-market accounting is misguided.
Mark-to-market is entirely appropriate for goods that trade in liquid markets. Open up your brokerage statement. If you see a notation that your account gained or lost X% of value, that is an application of mark-to-market. The securities you own did not change. The only thing that changed is the value at which identical securities were traded at the end of each period.
Mark-to-market accounting is widely used to mark the value of liquid financial instruments, such as stocks, bonds, and all forms of commodities that trade on exchanges.
The virtue of it is in providing an accurate picture of the actual change in wealth of the owner of these liquid securities. If you need to sell your securities, the price you will receive is not your cost- basis; it is the price at which identical securities are trading today, or something close to it, depending on how rapidly you must sell.
In contrast, cost-based accounting for liquid, traded securities is misleading; mark-to-market accounting provides the more accurate picture. If you called your broker to ask him how your account has done during this market meltdown, you would call him a cheat or a fool if he said not to worry because the stocks are worth what you paid for them. That would be an instance of applying cost-based accounting, which is entirely inappropriate for liquid securities.
Enron got into trouble by applying mark-to-market accounting to illiquid markets. A notorious example was when Enron used mark- to-market accounting to count as profits the present value of a 20- year agreement to sell telecommunications bandwidth to Blockbuster for the transmission of movies.
I am not an accountant, but I use accounting statements professionally in analyzing stocks. Accounting is a highly contextual discipline. The appropriate method depends on what is being accounted and for what purpose. Above all, accounting requires honesty. A crook can always cook the books, and he can do it just as easily using mark-to-market, accrual, cash-based, or cost-based accounting.
The government should issue no rules regarding mark-to-market accounting. These should be private decisions made by accountants, investors, and their representative organizations, such as the stock exchanges. Already, by dictating many accounting methods the SEC just makes financial statements harder to understand, which keeps stock analysts, lawyers, and accountants very busy, and creates a fertile field of complexity for future Andy Fastows [1] to walk through.
[1] Andrew Fastow was the CFO of Enron. He is currently serving a six-year prison sentence.
Raymond C. Niles has worked as a stock analyst and fund manager on Wall Street for the past 14 years. Mr. Niles holds an M.B.A. (with Distinction) in Finance and Economics from the Stern School of Business at New York University. He currently manages an investment fund based in New York City.
http://www.capmag.com/article.asp?ID=5347
November 5, 2008 at 4:28 am · Filed under Accrual Accounting
Bookkeeping based upon cash accounting principles is the easiest accountancy practise but not necessarily the most accurate or beneficial for tax purposes for the business. This is because cash accounting adopts the date of financial documents such as sales invoices and purchase invoices as the automotive date for those primary financial records to be entered into the accounts.
The date entered on the sales or purchase receipt is called the tax point. The tax point does not determine the spread of that transaction over the tax period which can be different when accounts are prepared on an accruals basis as opposed to a cash basis.
For the purposes of cash accounting the effective inclusion of the transaction in the financial records is the date the cash or bank receipt or payment was made. The tax point date on the document is not the deciding factor to include the item in the accounts. The determining factor is the date the transaction amount was received or paid out be that in cash or bank.
There are disadvantages to maintaining accounts on a cash basis in that records must be kept of all payments received and paid out and those records supported by the actual primary accounting documents to which they relate. That entails matching the financial documents to the payments and receipts records, a feature many small businesses might find onerous.
Virtually all professional accountants adopt an accruals basis for clients accounting purposes as it is based upon recording all financial information whether relevant to the tax period or not and then adjusting the management accounting profit indicated to produce the net taxable profit or loss.
By operating an accruals basis all financial documents are recorded according to the tax point date. If all financial transactions during the year were paid for in that year then the cash basis and accruals basis would produce identical results.
The main adjustment a small business or the accountant might make to accounts prepared on the accruals basis is to first prepare the set of accounts according to the tax point of the primary accounting records and then examine those transactions and adjust them according to their relevance to the financial period for which the accounts are being prepared.
A typical example of the difference would be the rent invoice for the business premises. Let us assume a quarterly rent invoice was received dated 1 December for the 3 months from December 1 to February 28 which was paid by the small business owner by cheque on December 31 and a year end date also of December 31
On a cash basis the rent would not technically be included in the accounts as it would be shown as a rent payment from the business bank account on January 2 or later if cashed by the recipient at a later date. Therefore that quarters rent would be included in the following year accounts not the current year as issuing a cheque is not a payment but actually a promise to pay.
If the rent was paid in cash prior to the 31 December then the whole 3 months rent would be included in the current accounting records. That treatment may have distorted the accounts as more or less than 12 months rent might have been included in the tax calculations.
On an accruals basis the rent invoice would have been entered in the accounting records with an effective date of December 1. Using accrual accounting the accountant or small business owner preparing the accounts would then deduct 2 months rent as a prepayment leaving one months rent in the current year accounts.
That is more accurate as the other side of the accounting would be for that same accountant or bookkeeper to further include the 2 months rent not already claimed to be included in the tax calculation for the next financial year. That is how prepayments are treated when a business uses the accruals accounting basis.
Further when using the cash accounting basis only those transactions paid for or received are included. On an accruals basis additional expenses can be added that may not have even been invoiced yet on the basis that the costs incurred were relevant to the accounting period for which the books are being prepared.
Cash accounting might appear easier but has the disadvantage of maintaining receipts and payments records in addition to the primary documents which should also be matched to the financial transactions to support the accounts.
Accrual accounting is based upon recording all financial transactions and then adjusting the end result to determine the most accurate net taxable profit. The accruals basis is favoured by accountants as it reaches an accurate tax liability as opposed to more or less tax being payable on the cash basis according to the credit control policies and practises of the business its suppliers and clients.
About the Author
Terry Cartwright, CEO DIY Accounting, a qualified accountant in the UK, designs Accounting Software on excel spreadsheets and Payroll Software for small to medium sized business providing a complete accounting solution and also supplies Company Formation packages for new limited liability companies
