An Overview of the Accrual Method
Under the accrual method of accounting, you report income when you earn it and expenses when you incur them, regardless of when the money actually changes hands.
For example, if you receive a bill in October but you do not pay it until January, you would report the expense when the bill is received under the accrual method of accounting.
In contrast, if you used the cash method of accounting, you would not record that expense until January when the bill is paid.
Advantages of the Accrual Method
The key advantage of the accrual method is that it allows you to see a relatively accurate picture of your revenue and expenses as they are incurred.
Essentially, the accrual method makes it easier for businesses for track trends — business owners gain a clear sense of the deals they are making as well as the upcoming obligations and expenses they have.
For example, imagine you make a consistent number of deals every month, but send your clients invoices instead of billing them immediately. One month, almost all of your clients pay their invoices. However, the following month, hardly anyone pays.
Under the accrual method of accounting, you record deals as you make them. This method of accounting reflects the fact that business is steady and consistent. However, under the cash method of accounting, you do not report your payments until you receive them. As a result, your business appears to be booming one month and failing the next.
Disadvantages of the Accrual Method
Unfortunately, if you use the accrual method, you may occasionally end up reporting income to the CRA that you have not yet received and may be taxed on this income.
On the other hand, you may also be able to deduct expenses which you have yet to actually pay and this can help to counter balance that effect.
It’s important to keep records that show both when your income and expenses were earned and incurred, as well as when they were paid.
For example, to support your income claims, you should keep records such as sales invoices, cash register tapes, receipts, bank deposit slips and contracts.
If the CRA decides to review or audit your return, these records are required to back up your claims. However, they can also be used to back up claims for bad debts.
For example, imagine you file your income tax return and report that you have earned income from a client based on a contract you have signed. However, the following year, that client fails to pay you. In this case, using the records you have, you can claim the unpaid debt as a business expense against the rest of your income.
Whether you’re using accrual or cash methods, filing your small business’s tax return is easy with TurboTax Self-Employed. We also have a team of tax experts waiting to assist you with your tax return, review this link for more detailed information on our LIVE team.