In most cases, if you are reporting business income to the Canada Revenue Agency, you must use the accrual method of accounting. However, if you are reporting farming, fishing or commission income, you can choose between the cash and accrual methods of accounting.
It’s important to understand the cash method to decide which method is right for you.
Overview of the Cash Method
Under the cash method of accounting, you report your income when you receive it and your expenses when you pay them.
This contrasts with the accrual method where you report your income when you earn it and your expenses when you incur them, regardless of when you actually collect or spend the money.
For example, imagine you did a job in November 2020 but you are not paid until January 2021. Under the cash accounting method, you would report this income on your 2021 tax return. Under the accrual method, you would instead report this income in 2020.
Advantages of the Cash Method
The cash method offers you a more accurate look of your current finances. Additionally, when you file your income tax return using the cash method, you are not at risk to pay tax on income you have yet to collect.
Disadvantages of the Cash Method
While the cash method can be beneficial, it does not necessarily accurately reflect the financial state of your business.
For example, imagine your business dips one month. In the same month, you also receive a lot of past due payments from old clients. As you use the cash method of accounting, your records for this month show your income as booming. However, your business actually facing financial struggle that month.
This is one of the reasons that some business owners choose the accrual method — it gives a more comprehensive and understandable idea of trends in business earnings.
The CRA requires you to keep records related to your business income and expenses. If you use the cash method of accounting, you should keep records showing both your bills and your payments.
For example, if you have a business cell phone bill, you should keep your bill as well as a copy of your bank or credit card statement showing the date you made the payment.
Similarly, if you collect income from clients, you need to keep a record of their actual payments, not just records of your invoices.
Changing Accounting Methods
If you have been using the accrual method and you want to change to the cash method, you simply need to complete your next tax return using the cash accounting method.
However, you also need to look at previous returns, calculate adjustments you need to make, and attach a note to your return that explains them.
If you are currently using the cash method but want to change to the accrual method, you must submit your request for change through your nearest tax services office before the due date of the tax return.