The accrual basis of accounting is commonly used by businesses to record their daily activities. Using the accrual basis allows the business to record accounts receivable, accounts payable, loans, and accrued expenses. Consideration is given to income that is almost earned, such as goods or services that have been delivered but the business is waiting for payment, and expenses associated with generating that income that have been incurred but not yet paid for. However, many businesses utilise the cash basis of accounting for their tax return. When using the cash basis the business simply records revenue when collected and expenses when paid. Although differences occur between the two accounting methods due to the differences in the recording of income and expenses, the two methods can be reconciled.
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- Accrual basis books and records
Adjust the accrual basis accounts to cash, or tax, basis. These adjustments will affect a balance sheet account and an income statement account. For example, to reconcile accounts receivable, an accrual basis account, subtract the opening accounts receivable balance from the year-end adjusted accounts receivable balance. The result indicates the increase or decrease in sales for the year. Adjust the sales account for this amount. For example, if opening accounts receivable was £325,000 and the year-end adjusted accounts receivable was £455,000, the positive difference of £130,000 would be added to sales. The positive £130,000 indicates the amount by which cash collections on sales increased. If the result was a negative number, it would be subtracted from the sales to reflect the outlay of cash, and therefore extension of credit to customers. Adjusting the sales for the change in accounts receivable reconciles the sales from the accrual basis of accounting to the cash, or tax, basis of accounting by removing accrued revenues included in the accounts receivable account.
Make the same adjustment for accounts payable. Since liability accounts have credit, or negative, balances, a negative number that results from subtracting the opening balance from the year-end adjusted balance is added to the expenses. A positive result is subtracted from the expenses because it represents a debit balance. Allocate the accrued costs calculated to the appropriate line items of your income statement. By doing this, the accrued expenses are removed from the accounts payable.
Make comparable adjustments to other accrual basis balance sheet accounts. Accrual basis accounts include deferred tax liability and accrued expenses. Calculate the change in the accounts and offset the result against the appropriate income statement account.
Adjust your cash basis income for income and expenses which are limited or are reported by shareholders instead of the business. For example, if the business is an S-Corporation or a Partnership, interest income and charitable contributions will be reported by the shareholders and partners, not the businesses. Accordingly, add or subtract these items from the accrual basis income. Expenses for meals and entertainment are limited on the business tax return to one-half of what was reported. To reconcile to the tax return, subtract one-half of the meals and entertainment.
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