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Accounting Services: Accounting Methods, Which Fits Best

Located in Puyallup servicing Puyallup, Tacoma and McMillin

The two most common methods of accounting are the Cash method and the Accrual method. For most bookkeepers, accountants, and tax professionals, the easiest is always the Cash method. However, that is not always in the best interest of the business owner or fits both the short and long-term business goals and needs. The Cash method is related to there is no time in between the change of property or services. You give a customer a product or service and the customer pays you. Think of Retail or e-Commerce, You go to the store load your cart up with groceries and check out. The cashier rings your groceries up and you pay the bill for the groceries and leave. Same with e-Commerce, you order something online the online shop takes your payment and ships your order to you.

On of the biggest down falls in this method is it does not match the expenses you pay out to the sales you bring in. Let say you pay for a year of insurance. Money leaves the bank to pay the insurance company right away. You are now covered for insurance for the year. In actuality you have not used a years’ worth of insurance up yet. It skews your income because it is not matched to what you paid out in insurance compared to what you actually used.

The Accrual method is related usually to when a company extends credit to its customers. The biggest difference is transactions are matched to the time frame they occurred. Take the same example as above for the insurance. You paid out for a year of Insurance. Instead of it being recorded all at once as an expense. It is put aside as a prepaid expense. Even though the insurance was all paid for up front. The expense is moved a little at a time from the prepaid expense to the actual expense as insurance is used, usually every month. It matches the expensed insurance to the insurance that is actually used in the same period. The normal skewed income is now allocated proportional to the amount used.

Let’s say that you allow your customers 30 days to pay for services they receive. You are extending credit. They received your services and you have not been paid yet. You may have paid for supplies and materials already on your customers behalf. It seems much more logical to match the expenses you paid for on your customers behalf to be able to match them to the income that is due in 30 days from the customer. This is where the accrual method works better.

It can also be related to long term contracts such as with Boeing Aircrafts for example. Boeing may get a contract order for a aircraft. The aircraft is not built yet, but the contract has a dollar value. The value may be recorded as unearned sales or revenue. As the plane is built Boeing could move the unearned portion towards sales and possible invoice the customer for the work that has now been completed to earned revenue or sales. The process would continue until the plane is complete the contract complete and Boeing has received all the money related to the sale.

The question remains on which accounting method servers your current business needs and your future business needs. The decision should be completed before your first set of business taxes or individual taxes depending on your business structure. You should relay your accounting method you selected to your tax professional who is going to do your taxes.

Author: Fred Pugaczewski, BC&FS

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