What Is an Accounting Method?

An accounting method refers to the rules that a company follows in reporting revenues and expenses. The two primary methods of accounting are accrual accounting༺ (generally used by companies) and cash accounting (generally used by individuals).

澳洲幸运5官方开奖结果体彩网:Cash accounting reports revenues and expenses as they are received and paid through cash inflows and outflows; 澳洲幸运5官方开奖结果体彩网:accrual accounting reports them as they are earned and incurred through sales and purchases on credit and by using accounts receivable and accounts payable. 澳洲幸运5官方开奖结果体彩网:Generally 🀅accepted accounting principles (GAAP) require accrual accounting.

Understanding an Accounting Method

All businesses need to keep accounting records. Public 澳洲幸运5官方开奖结果体彩网:companies are required to do so. Accounting allows a b💮usiness to monitor every aspect of its finances, from revenues to costs to taxes and more. Without accurate accounting, a business would not know where it stands financially, most likely resulting in its demise.

Accounting is also needed to pay accurate taxes to the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS). If the IRS ever conducts an audit on a company, it looks at a company’s accounting records and methods. Furthermore, the IRS requires 澳洲幸运5官方开奖结果体彩网:taxpayers to choose an accounting method that accurately reflects their income and to be consistent in their choice of accounting method from y🐭ear to year.

This is because switching between methods would potentially allow a company to manipulate revenue to minimize its tax burdens. As such, IRS approval is required to change m♛ethods. Companies may use a hybrid of the two methods, which is allowable under ๊IRS rules if specified requirements are met.

Types of Accounting Methods

Cash Accounting

Cash accounting is an accounting method that is relatively simple and is commonly used by small🌠 businesses. In cash accounting, transactions are only recorded when cash is spent or received.

In cash accounting, a sale is recorded when the payment is received and an expe✤nse is recorded only when a bill is paid. The c𓆉ash accounting method is, of course, the method that most people use in managing their personal finances and is appropriate for businesses up to a certain size.

If a business generates more than $25 million in average annual gross receipts for the preceding three years, however, it must use the accrual method, according to IRS rules.

Accrual Accounting

Accrual accounting is based on the matching principle, which is intended to match the timing of revenue and expense recognition. By matching revenues with expenses, the accrual method gives a more accurate picture of a company’s true financial conditioജn.

Und🌸er the accrual method, transactions are recorded when they are incurred rather than awaiting payment. This means a purchase order is recorded as revenue even though the funds are not received immediately. The same goes for expenses in that they are recorded even though no payment has been made.

Example of an Accounting Method

The value of accrual accounting becomes more evident for large, complex businesses. For example, a construction company may undertake a long-term pr🎃oject and may not receive complete cash payments until the project is complete.

Under cash accounting rules, the company would incur many expenses but would not recognize revenue until cash was received from the customer. So, the accounting book of the company would look weak until the revenue actually came in. If this company was looking for 澳洲幸运5官方开奖结果体彩网:debt financing from a bank, for🎶 example, the cash accounting method makes it look like a poo🃏r bet because it is incurring expenses but no revenue.

Under accrual accounting, the construction company would recognize a percentage of revenue and expenses corresponding to the portion of the project that was completed. This is known as the 澳洲幸运5官方开奖结果体彩网:percentage of completion method. How much actual cash is coming i📖nto the company, however, would be evi♒dent in the cash flow statement. This method would show a prospective lender a much more complete and accurate picture of the company’s revenue pipeline.

The Bottom Line

An accounting method is the rules that a company must follow in reporting revenues and expenses. Accrual accounting (used mostly by companies) and cash accounting (used mostly by individuals) are the two primary accounting methods.