Accrual-Based Reporting vs. Cash-Based Reporting
Every business owner needs to understand recognition methods and choose the one that will best fit their company structure. In making this decision, you will answer WHAT you will be recognizing as earned revenues/sales and expenses. This is an important decision, as your recognized numbers are the ones you report to outside agencies, such as tax authorities and investors. You should ALWAYS seek the guidance of a Certified Public Accountant before making the decision on recognition, and implement it before your first year of booked transactions is officially closed out. (This decision could mean that you will pay taxes on earnings that your bank account does not yet reflect).
For illustration purposes, suppose that you sent a customer an invoice for $1,000 for services that you already performed for them. The date of this invoice is 12/31/16. Now let’s assume that the customer paid your invoice promptly within the stated 10-day terms, and you received the payment by January 10, 2016. You then deposited the payment into your bank account.
Under accrual-based reporting, you would be claiming this income in 2015 because you earned the income in that year, even though you did not receive the income in that year. Accrual-based reporting means that you recognize the income as it accrues (as it is earned), regardless of when you get paid. You will owe taxes on this $1,000 for 2015.
If, instead, you and your CPA had determined that cash-based reporting was a better fit, you would not include this $1,000 on your 2015 taxes because you did not actually receive the funds until 2016. Under cash-based reporting, you do not recognize the income until you actually receive the funds. You will not be liable for taxes until you file your 2016 taxes.
QuickBooks offers a choice of reporting methods in processing your financial statements, and you can set this preference to avoid having to choose each time you process a report. Here is how to set your preference in QuickBooks Desktop: Edit>Preferences>Reports & Graphs>Company Preferences>Summary Reports Basis (upper left), choose either Accrual or Cash:
Here is how you would set this preference in QuickBooks Online: Click on the wheel in the upper right-hand corner of your home page>Settings>Company Settings>Company>Accounting Method:
Remember, this is for reporting purposes only. You can continue with your bookkeeping without even thinking about recognition, but the reports you process will use your chosen method of recognition for both revenues and expenses.
While I have gone over some of the basics here, there is a lot more information about Accrual vs. Cash Basis reporting. Ultimately, you should be consulting with your CPA on this very important decision.
Still have questions? Email them to firstname.lastname@example.org. We are happy to help!