The cash method of accounting, also known as cash-basis accounting, cash receipts and disbursements method of accounting or cash accounting (the EU VAT directive

vocabulary A vocabulary (also known as a lexicon) is a set of words, typically the set in a language or the set known to an individual. The word ''vocabulary'' originated from the Latin , meaning "a word, name". It forms an essential component of languag ...

Article 226) records revenue when cash is received, and expenses when they are paid in cash. As a

basis of accounting In accounting, a basis of accounting is a method used to define, recognise, and report financial transactions. The two primary bases of accounting are the cash basis of accounting, or cash accounting, method and the accrual accounting method. A ...

, this is in contrast to the alternative

accrual In accounting and finance, an accrual is an asset or liability that represents revenue or expenses that are receivable or payable but which have not yet been paid. In accrual accounting, the term accrued revenue refers to income that is recogni ...

method which records income items when they are ''earned'' and records deductions when expenses are ''incurred'' regardless of the flow of cash.

Cash method of accounting in the United States (GAAP)

Use in contract accounting

The cash method of accounting has historically been one of the four methods of recognizing revenues and profits on contracts, the other ones being the

accrual method In accounting, a basis of accounting is a method used to define, recognise, and report financial transactions. The two primary bases of accounting are the cash basis of accounting, or cash accounting, method and the accrual accounting method. A ...

, the

completed-contract method The Completed-contract method is an accounting method of work-in-progress evaluation, for recording long-term contracts. GAAP allows another method of revenue recognition In accounting, the revenue recognition principle states that revenues are ...

and the

percentage-of-completion method Percentage of completion (PoC) is an accounting method of work-in-progress evaluation, for recording long-term contracts. GAAP allows another method of revenue recognition for long-term construction contracts, the completed-contract method The Com ...

s. Since the

Tax Reform Act of 1986 The Tax Reform Act of 1986 (TRA) was passed by the 99th United States Congress and signed into law by President Ronald Reagan on October 22, 1986. The Tax Reform Act of 1986 was the top domestic priority of President Reagan's second term. The ...

, the cash method can no longer be used for

C corporation A C corporation, under Income tax in the United States, United States federal income tax law, is any corporation that is taxed separately from its owners. A C corporation is distinguished from an S corporation, which generally is not taxed separ ...

s, partnerships in which one or more partners are C Corporations,

tax shelter Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. The methodology can vary depending on local and international tax laws. Types of ...

s, and certain types of trusts. Because of the 1986 reform, in general, construction businesses do not use the cash method of accounting. Some construction businesses use the cash method, and there are many other companies that use a modified form of the cash method, which is acceptable under federal income tax regulations. Under the modified cash method of accounting, most income and expenses are determined under cash receipts and disbursements, but purchases of equipment and items whose benefit will cover more than one year is to be capitalized, whereas such items as depreciation and amortization are charged to cost.

Use in other types of businesses

The cash method of accounting is also used by other types of businesses, such as farming businesses, qualified personal business corporations and entities with average gross receipts of $5,000,000 or less for the last three fiscal years.

Advantages for tax planning and IRS stand

There are certain advantages in

tax planning Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable. A tax shelter is one type of tax avoidance, and tax havens are jurisdictions that facilitate reduced taxe ...

when the cash method of accounting is used: for instance, payment of business expenses may be accelerated before year end, in order to maximize

tax deduction A tax deduction or benefit is an amount deducted from taxable income, usually based on expenses such as those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and tax credits. The diff ...

s, whereas billings for services may be postponed to after year end, so that payments won't be received until the new year, thus postponing tax payments on such income. Because of these advantages and the manipulations that can occur with it in order to minimize taxable income, the

IRS The Internal Revenue Service (IRS) is the revenue service for the Federal government of the United States, United States federal government, which is responsible for collecting Taxation in the United States, U.S. federal taxes and administerin ...

has discouraged (although not prohibited entirely) the cash basis of accounting for tax purposes. For instance, companies that use the cash basis of accounting may not report any inventory in their financial statements, in fact reporting of any inventory at year end can lead to manipulation of taxable income to an enormous extent.

References

{{reflist Accounting systems Cash

Cash method of accounting in the United States (GAAP)

Use in contract accounting

Use in other types of businesses

Advantages for tax planning and IRS stand

See also

References