Cash or Accrual Basis??
I love the T-shirt that says “ it’s accrual world.” A little spin on the accounting term accrual. One of my favorite questions to ask a new client when I onboard them is, "Are your books done on a cash basis for an accrual basis? I have found most of the people that I work with, don’t know the answer to that question.
Remember when looking at the books, it is all about timing of when the sales are recorded and when the expenses are recorded and when both are recognized on the financial statements. Cash basis method or Accrual basis method are recognizing revenue and expenses in vastly different ways.
ProAdvisor Tip: A simple ask for their last tax return will reveal the answer. However, that is a great teachable moment to have dialog with the client about the differences. Use the tax return to create an entry to tie the books to the return.
Cash Based Books
- 1Generally smaller businesses
- 2Sole Proprietorships, LLC's, Partnerships and S-Corps are the business entity types that can file as cash basis
- 3Money in and money out
- 4Most businesses start out this way
- 5No inventory
- 6Sales under 5 million dollars
Accrual Based Books
- 1Generally larger businesses
- 2C Corps are required to do their books as accrual based
- 3Invoices are included in revenue and bills are included as expenses
- 4Real time records/GAAP compliant
- 5The business has inventory
- 6Sales over 5 million dollars
Law Firm Client Clean Up Story....
Recently, we came across a customer who had cash-based books. On their tax return, the year-end trust account balance should have tied back to the tax return. The client provided a list of all the clients that totaled this trust balance. However, there were many checks written to this law firm dated December 31, 2018, that was in payment of legal services rendered to the law firm. These checks were not cashed until mid-January, and the entry of this income was not recorded until 2019. As we dug through the books, we found that there was no entry whatsoever to what we accountants call "book to tax." This trust account year-end balance had a lower balance because of the outstanding checks not recognized as revenue until 2019. This issue caused enormous headaches for us and trying to tie the books to the tax return. The tax professional should've created an entry accounting for these uncleared checks.
We had to create an adjusting entry to account for this income in 2018 since their Trust Accounting showed the movement of these funds in 2018. If we had not done that, there was no way to tie the Trust Bank account to the Trust Account records. See my article on Trust Accounting here for why the bank balance and the individual trust accounts must equal.
Even though most of my clients are cash based, I let them look at their records in accrual basis during the year. It is more of a real-time look at the books. Then at year-end, I create a grouping of reports as cash basis so that I can get the records ready for the tax professional.
Still Confused and Need Help?
Call us today! We can help you clean up your books and tie them to the tax return for you!
Here is a link to the article I wrote on cleaning up unapplied cash payment income. I hope you enjoyed the article. Feel free to send me a message on Facebook and give me some suggestions of names for my law firm test/sample account.