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Accounting Periods and Methods for Businesses

Accounting Periods and Methods for Businesses

Uncle Sam advises all taxpayers, which involves individuals and businesses, to estimate their accounting period in a year referred to as a tax year. Although, It is generally agreed that the Calendar year will serve as the tax year. However, in some cases, the tax year might have short tax years, 52 to 53 weeks, and fiscal years. 

Detailed information on choosing an accounting tax year is available for all in Accounting Periods, IRS Pub 538.

 All taxpayers need to be consistent with their approach to accounting. We define this as a set of guidance that helps determine the method and time to report expenses and income. There are two common types of accounting methods commonly used – the cash method and the accrual method. 

The cash method involves reporting an income at the same tax year when you got it and removing the expenses in the same year you paid the tax. On the other hand, the accrual method involves reporting income in the very year it was earned. It did not matter when the payment came in, and you will remove the expense in the same tax year you got them. 


Sample Cash Method Approach 

John Walter is a consultant who got 43,000 USD on a contract in the last month of the year. John, however, intends to keep the check till the next year, January, to postpone paying tax till the coming tax year. Even with this, John must include this amount in the current year's income since that is the year the funds were paid. 


Accrual Method Approach 

Madison is the owner of a hair salon. She is guided by the accrual accounting method and also observes the calendar tax year. Madison sold 700 USD for seven consecutive months starting in September and paid the full 700 USD in September. She includes 300 USD of the payment in the current tax year and deferred the remaining 400 USD to the next year that the contract will be completed. 

Business owners should have an inventory that will reveal vital information like income when the purchase, production, or sale of an item can be classified as an income-generating factor. Business owners need to account for the inventory in their business by employing the accrual approach to accounting, which considers every sales and purchase. 


Changing Your Accounting Method

After setting up your preferred accounting method and sending in your first tax return, Uncle Sam will send you a notice of approval if you need to change your approach. If your current approach reveals your income clearly, Uncle Sam will prioritize the need to be consistent in reporting against why you need to change. 

IRS publication 538 (Accounting Periods and Methods) has essential information on accounting methods. 


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