Switching From the Accrual to Cash Method of Reporting

In most cases, the Canada Revenue Agency requires small business owners to use the accrual method of accounting. However, if you own a fishing or farming business or work as a commissioned salesperson, you can choose either method.

If you are currently using the accrual method of accounting, you are recording income when you earn it, instead of when it is paid to you. Similarly, you are reporting expenses when you incur them, rather than when you pay them.

If you switch to the cash method of accounting, you will not record your income or expenses until you have actually received or spent the money.

To switch to the cash method, you need to adjust your records. Look through your records and remove any income that you have not actually received yet.

For example, imagine you made a deal to do some work for a client. Under the accrual method of accounting, you would have already included this income in your records. However, you haven’t actually been paid yet. If you are switching accounting methods, you need to remove this income from your records and only include it when you receive the payment.

Similarly, you need to remove incurred expenses from your records until you have actually paid them.

As long as your business is eligible to use the cash method of accounting, you do not have to get permission from the CRA to change to the cash reporting method.

Instead, simply complete your income tax return using the cash method. Then, attach a note to your return stating that you have switched from the accrual to cash methods of accounting. You must also attach a statement showing your income and expense adjustments.

It is important to make logical adjustments and accurately report these to the CRA. For example, imagine you claimed an expense on your previous year’s return. You claimed it because you received the bill or otherwise incurred the expense. However, you did not actually pay the bill during that tax year. Instead, you paid it the following year.

As you are now using the cash method of reporting, you would typically report this expense on your current year’s return. However, you cannot claim the same expense twice and must explain your decision to the CRA.

This is the type of issue the CRA expects you to address in the statement of your income and expenses adjustments.

There are pros and cons of both the cash and accrual accounting methods. For example, by switching to the cash method of reporting, you ensure you do not have to pay income tax on income you have not yet received.