Should I Use the Cash or Accrual Method of Accounting?

woman counting cash

You may not be aware that you’re supposed to choose an accounting method to keep track of your income and expenses for your taxes, whether you are an individual or a business. But how are you supposed to choose between the cash or accrual method of accounting, and what do those terms even mean?

The Cash Method of Accounting

Most individuals, whether they realize it or not, use the cash method of accounting in their day-to-day lives and for their taxes. The cash method is basically what it sounds like: you record income on the day you receive it (when the cash comes in) and record expenses on the day you pay them (when cash goes out). It’s the easiest way to keep track of all of your cash flow.

The Accrual Method of Accounting

The accrual method functions a little differently. Instead of keeping track of when the cash goes in and out, you keep track of when you earned the income or received the invoice, not when you received or paid the cash. This form of accounting is most often used by larger businesses and/or businesses who retain an inventory to keep better track of how their business is doing.

Do I Really Have to Choose a Method of Accounting?

Believe it or not, yes, you do. When you file your first tax return, you will use one method or the other. If you don’t remember ever really choosing one (don’t worry, you’re not the only one), you’re probably using the cash method. If your or your business’s financial life is fairly simple, it makes sense to use the cash method.

But Some Entities Are Required to Use Accrual Basis Accounting

Corporations, except for S corporations, are required to use accrual basis accounting. Also, if a business’s gross receipts exceed $29,000,000, it must use the accrual method.

Changing Your Mind

You can change your mind about which accounting method to use, but you will have to get approval from the IRS. Yes, for real.

Whether you use the cash or accrual method of accounting, we can help you with your taxes. Contact a tax preparer today to get started.

**Please keep in mind: Tax laws, eligibility requirements, and rates change often, and these lists are not exhaustive. Always contact a tax preparer for the most up-to-date information.