Page 59 - DCOM508_CORPORATE_TAX_PLANNING

Corporate Tax Planning

Notes year. Likewise, it is possible to accelerate expenses by paying them as soon as the bills are
received, in advance of the due date. The cash method is simpler than the accrual method,

it provides a more accurate picture of cash flow, and income is not subject to taxation until
the money is actually received.
In contrast, the accrual basis makes a greater effort to recognise income and expenses in
the period to which they apply, regardless of whether or not money has changed hands.
Under this system, revenue is recorded when it is earned, rather than when payment
is received, and expenses recorded when they are incurred, rather than when payment
is made. The main advantage of the accrual method is that it provides a more accurate
picture of how a business is performing over the long-term than the cash method. The
main disadvantages are that it is more complex than the cash basis, and that income taxes
may be owed on revenue before payment is actually received. However, the accrual basis
may yield favourable tax results for companies that have few receivables and large current
liabilities.

Notes Under Generally Accepted Accounting Principles (GAAP), the accrual basis
of accounting is required for all businesses that handle inventory, from small retailers
to large manufacturers. It is also required for corporations and partnerships that have
gross sales over $5 million per year, though there are exceptions for farming businesses

and qualified personal service corporations-such as doctors, lawyers, accountants, and
consultants. Other businesses generally can decide which accounting method to use based
on the relative tax savings it provides.

Hence, we can conclude. Some form of record-keeping is required by law and for tax
purposes, but the resulting information can also be useful to managers in assessing the

company’s financial situation and making decisions. It is possible to change accounting
methods later, but the process can be complicated. Therefore it is important for small
business owners to decide which method to use up front, based on what will be most
suitable for their particular business.
2. Cash vs. Accrual Basis: A taxpayer chooses his accounting method when he fi les his

first income tax return. The Tax Code requires that taxpayers use a consistent method of
accounting from year to year. Thus, if a taxpayer wishes to change its accounting method it
must get permission to do so from the IRS. To request a change in accounting method you

must file IRS Form 3115. This is a highly complex form and should not be completed without

the assistance of a qualified CPA or tax attorney. The two most commonly used methods of
accounting are the Accrual and the Cash methods. The Cash Method of accounting allows
taxpayers to report their revenues when received and expenses when paid. More than 95%
of individual taxpayers use the Cash Method of accounting to report their taxable income
and deductible expenses on their Forms 1040. Under the Accrual Method of accounting a
taxpayer records his income when a sale occurs, not when payment is received. Likewise,
he records a deductible expense when it’s incurred, not when it’s paid.

Since the recognition of revenues and expenses under the cash method depends upon the
timing of various cash receipts and disbursements, however, it can sometimes provide a

misleading picture of a company’s financial situation. In contrast, the accrual basis makes
a greater effort to recognise income and expenses in the period to which they apply,
regardless of whether or not money has changed hands. Under this system, revenue is
recorded when it is earned, rather than when payment is received, and expenses recorded
when they are incurred, rather than when payment is made.

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