Accrual accounting

Accrual accounting

Two primary accounting methods, cash and accrual basis, are used to calculate taxable income income and company tax purposes. Companies are permitted to use cash accounting and compute taxable income by: the cash receipts and disbursements method, which is to account for income and expenditure as it is received and paid. Cash basis taxpayers include income when it is received, and claim deductions when expenses are paid.

Accounts may also be computed using an accrual method. The accrual basis accounts include items when they are earned and claim deductions when expenses are incurred. An accrual basis set of accounts looks to the “all-events test” and “earlier-of test” to determine when income is earned. Under the all-events test, an accrual basis taxpayer generally must include income for the taxable year when all the events have occurred that fix the right to receive income and the amount of the income can be determined with reasonable accuracy.

Under the "earlier-of test", an accrual basis taxpayer receives income when the required performance occurs and payment therefor is due, or payment therefor is made, whichever happens earliest.

Where a company chooses a methed to compute net income the taxpayer must compute taxable income using the same accounting method he uses to compute income in keeping his books. Also, the business must maintain a consistent method of accounting from year to year. Should he change from the cash basis to the accrual basis (or vice versa), he must notify the relevant authorities.

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