Cash method of accounting

The cash method of accounting, also known as cash-basis accounting, cash receipts and disbursementsmethod of accounting or cash accounting (the EUVAT directive vocabulary Article 226) records revenuewhen cash is received, and expenses when they are paid incash.[1] As a basis of accounting, this is in contrast to thealternative accrual method which records income itemswhen they are earned and records deductions when ex-penses are incurred regardless of the flow of cash.[2]

1 Cashmethod of accounting in theUnited States (GAAP)

1.1 Use in contract accounting

The cash method of accounting has historically been oneof the four methods of recognizing revenues and profitson contracts, the other ones being the accrual method,the completed-contract method and the percentage-of-completion methods. Since the approval by Congress ofthe Tax Reform Act of 1986, the cash method could nolonger be used for C corporations, partnerships in whichone or more partners are CCorporations, tax shelters, andcertain types of trusts.[3]

Because of 1986 regulation, in general, construction busi-nesses do not use the cash method of accounting. Someconstruction businesses use the cash method; and thereare many other companies that use a modified form of thecash method, which is acceptable under federal income-tax regulations. Under the modified cash method of ac-counting, most income and expenses are determined un-der cash receipts and disbursements, but purchase ofequipment and of items whose benefit will cover morethan one year is to be capitalized, whereas such items asdepreciation and amortization are charged to cost.[3]

1.2 Use in other types of businesses

The cash method of accounting is also used by othertypes of businesses, such as farming businesses, qualifiedpersonal business corporations and entities with averagegross receipts of $5,000,000 or less[4] for the last threefiscal years.[5]

1.3 Advantages for tax planning and IRSstand

There are certain advantages in tax planning when thecash method of accounting is used: for instance, paymentof business expenses may be accelerated before year end,in order to maximize tax deductions, whereas billings forservices may be postponed to after year end, so that pay-ments won't be received until the new year, thus postpon-ing tax payments on such income.[4] Because of these ad-vantages and the manipulations that can occur with it inorder to minimize taxable income, the IRS has discour-aged (although not prohibited entirely) the cash basis ofaccounting for tax purposes. For instance the companiesthat use the cash basis of accounting may not report anyinventory in their financial statements, in fact reportingof any inventory at year end can lead to manipulation oftaxable income to an enormous extent.[6]

2 Cash method of accounting ac-cording to IFRS

3 References

[1] Douglas J. McQuaig; Patricia A. Bille; Tracie L. Nobles;Judy McQuaig Courshon (3 March 2010). College Ac-counting, Chapters 1-12. Cengage Learning. pp. 185–.ISBN 978-1-4390-3878-9. Retrieved 4 March 2012.

[2] Treas. Reg., 26 C.F.R. § 1.446-1(c)(1)(ii)

[3] William J. Palmer; William Palmer; William E. Coombs;Mark A. Smith (15 September 1999). Construction Ac-counting & Financial Management. McGraw-Hill Profes-sional. pp. 25–26. ISBN 978-0-07-135963-4. Retrieved4 March 2012.

[4] Gerald E. Whittenburg; Martha Altus-Buller (7 Decem-ber 2009). Income Tax Fundamentals 2010. CengageLearning. p. 7. ISBN 978-1-4390-4411-7. Retrieved4 March 2012.

[5] Linda M. Johnson; Cch Tax Law Editors (April 2008).Federal Tax Course (2009). CCH. p. 97. ISBN 978-0-8080-1862-9. Retrieved 4 March 2012.

[6] Steven M. Bragg (12 February 2010). The Ultimate Ac-countants’ Reference: Including GAAP, IRS and SEC Reg-ulations, Leases, and More. John Wiley & Sons. p. 666.ISBN 978-0-470-59395-0. Retrieved 4 March 2012.

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2 4 SEE ALSO

4 See also• Basis of accounting

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