Accrual Basis


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Accrual Basis

A method of accounting that reflects expenses incurred and income earned for Income Tax purposes for any one year.

Taxpayers who use the accrual method must include in their taxable income any money that they have the right to receive as payment for services, once it has been earned. Any expenses that they may take as deductions when computing taxable income must be due at the time the deduction is taken. For example, suppose a surgeon performed a tonsillectomy in October 2003, and on December 31, 2003, he received a bill for carpeting installed in the waiting room of his office. He was paid the surgical fee on January 3, 2004, the same day he paid for the carpeting. The surgical fee will be included in his taxable income for 2003, the year in which he earned it, regardless of the fact that he was not paid until the following year.

His expenses for the carpeting can be deducted from his 2003 income because once he received the bill, he was bound to pay it. The fact that he did not pay for the carpeting until the following year does not prevent him from taking the deduction in 2003.

The accrual method of accounting differs from the cash basis method, which treats income as only that which is actually received, and expense as only that which is actually paid out. If the cash method were used in the above example, the payment of the surgical fee would be included as income for the 2004 tax year, the year in which it was received by the surgeon. The surgeon could deduct the cost of the carpeting only when he actually paid for it in 2004, although it had been installed in 2003.

Unearned income, such as interest or rent, is generally taxed in the year in which it is received, regardless of the accounting method that the taxpayer uses.

References in periodicals archive ?
A study by Christiaens, Reyniers, and Rolle (2010) showed that the adoption of IPSAS in Europe has occurred at different levels, but accrual basis accounting (while sometimes not aligned with the international standards) was used in 80% of countries surveyed.
Before assigning the first case, the instructor should review the basic accounting equation and expand the equation to focus on differences between the cash basis and accrual basis: Add simple matrices that show the additions and subtractions involved with conversion of the cash basis to the accrual basis.
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Businesses operating on a cash basis rather than an accrual basis for yearend taxes "have an advantage" in being able to manipulate their cash holdings at year-end, Murtishaw said.
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The other is a provision that would reinstate the installment method of accounting for accrual basis taxpayers.
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