An accounting method is a set of rules used to determine when and
how income and expenses are reported. You choose an accounting method
for your business when you file your first income tax return. There
are two basic accounting methods.
- Cash method. Under the cash method, you report
income in the tax year you receive it. You usually deduct or
capitalize expenses in the tax year you pay them.
- Accrual method. Under an accrual method, you
generally report income in the tax year you earn it, even though you
may receive payment in a later year. You deduct or capitalize expenses
in the tax year you incur them, whether or not you pay them that
year.
For other methods, see Publication 538.
If you need inventories to show income correctly, you must
generally use an accrual method of accounting for purchases and sales.
Inventories
include goods held for sale in the
normal course of business. They also include raw materials and
supplies that will physically become a part of merchandise intended
for sale. Inventories are explained in Publication 538.
Certain small business taxpayers may be eligible to adopt or change
to the cash method of accounting and may not be required to account
for inventories. For more information, see Publication 538.
You must use the same accounting method to figure your taxable
income and to keep your books. Also, you must use an accounting method
that clearly shows your income. In general, any accounting method that
consistently uses accounting principles suitable for your trade or
business clearly shows income. An accounting method clearly shows
income only if it treats all items of gross income and expense the
same from year to year.
More than one business.
When you own more than one business, you can use a different
accounting method for each business if the method you use for each
clearly shows your income. You must keep a complete and separate set
of books and records for each business.
Changing your method of accounting.
Once you have set up your accounting method, you must get IRS
approval before you can change to another method. A change in
accounting method not only includes a change in your overall system of
accounting, but also a change in the treatment of any material item.
For examples of changes that require approval and information on how
to get approval for the change, see Publication 538.
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