If you are a fisher, farmer or commissioned sales agent, the Canada Revenue Agency allows you to choose between the cash and accrual methods of accounting when completing your income tax return.
However, the CRA has specific rules on what you need to do if you want to switch from the cash to accrual method. Here’s what you need to know.
Differences Between the Cash and Accrual Methods
- Under the cash method of accounting, you report income when you receive it and claim expenses when you pay them.
- If you use the accrual method, you report income when you earn it and expenses when you incur them.
For example, if you agree to a sale with a client, under the cash method, you would not report the income until you receive the money from your client. However, under the accrual method, you report the income when you finalize the sale regardless of when the client pays the invoice.
Adjusting Your Financial Records
To switch from the cash to accrual method of accounting:
- Start by adjusting your books or accounting software.
- If you have invoices, contracts from clients or other proof of upcoming income, you need to add these amounts to your accounting record.
- Similarly, if you have incurred expenses which you have yet to pay for, you need to include these in your accounting records as well.
To make this task easier, use business accounting software that uses the accrual method.
Notifying the CRA
In order to switch from the cash to accrual method, you need to get permission from the CRA.
Submit a written request to your nearest tax services office before the due date of your taxes. Although the CRA does not specify a due date for the request letter, you should submit it as soon as possible. This increases the chance you will receive a response before you start completing your income tax return.
If you are filing the first income tax return of your business, you do not need to submit a request to use the accrual method. You can simply opt to use it. You only need to submit a change request if you have previously filed you return using the cash method.
What to Expect
During your first year using the accrual method, it may seem as if you have more income.
For example, imagine you earned income and incurred expenses near the end of the last year you used the cash method. You didn’t report these amounts on that year’s return as you were using the cash method. However, if you had been using the accrual method, they would have been included on that year’s return.
When you switched to the accrual method of accounting, you included these amounts in your records. Although your income hasn’t changed, this method of accounting can make it look inflated.