Canuckbusiness

Start a business, Do your taxes, Save money

Accrual vs. Cash method: when do I report income?

Last post I talked about recording revenue. This post I’d like to talk about timing.

What if someone buys their spouse a $100 gift certificate from Bob the Massage Guy on Dec. 24th, 2011. (Yeah, I know this would never happen, right?)

The spouse (let’s say it’s the wife, just for the sake of simplicity) uses the gift cerfificate on Jan. 3rd, 2012, the same day the kids go back to school.

Does Bob record the $100 sale as revenue on his 2011 tax return? After all, he received it in 2011…

The short answer is “No.”

The Canada Revenue Agency wants you to use the “Accrual Method” of reporting business income (in almost all cases but there are some exceptions I’ll talk about below). With the Accrual Method, it doesn’t matter when you actually receive the cash, you report your revenue in the period you earn it. In this case, Bob actually “earns” the revenue when he performs the service (the massage), which is on Jan. 3rd, 2012. Therefore, the $100 for the massage would be included in his revenue total for 2012, not 2011.

The same rule applies to expenses. You must report expenses in the period you incur them. Another way of saying this, is you report revenue when it is earned and the expenses associated with earning that revenue in the same tax year. CRA wants you to do this so it gives a more accurate view of your Net Income.

So if Bob had to buy some expensive, unique oil particular to that one client, the expense for that oil would go in one of his envelopes for 2012, the same year the revenue is recognized.

Awesome! I collect cash and don’t have to claim it until the next year!

Uh, don’t get too excited.

Let’s look at another scenario. Say Bob gives Larry a massage on Dec. 12, 2011, but Larry forgot his cash so he says he’ll pay Bob later. Larry forgets all about poor Bob and doesn’t actually get around to paying him until Jan. 15, 2012. When does Bob report the revenue?

Bob must report the revenue in the period it was earned. It was earned when he gave the massage. So, it goes on his 2011 tax return even though he never actually received the cash.

Bummer.

And what if Larry NEVER pays? Bob has already paid tax on money he will never see. That would hardly be fair, so CRA allows a “Bad Debt Expense”. At the point Bob is pretty sure Larry is not going to give him any money, Bob can claim a “Bad Debt Expense” equal to the amount that he included in income in a previous year.

That is the kicker. If you want to claim a bad debt expense you have to have first included it in income in some previous year.

Exceptions

The common one that comes to mind is self-employed commission sales agents (eg. real estate agents). These people tend to be paid in large lump sums only a few times a year, so CRA lets them use a “Cash Method” of reporting income and expenses, as long as it shows an accurate picture of their income for the year. This means they show revenue in the year they receive it and expenses in the year they pay them.

Report it when you get it or pay it. That’s the cash way. Fishermen and farmers are also allowed to report on a variation of this method.

But the rest of us are stuck with the Accrual Method. And unfortunately, guys like Larry.

July 19, 2011 - Posted by | Running Your Business, Uncategorized | , , , , , ,

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