Accounting

The End of Cash Accounting?

Sep 18, 2014 | By Chris Sluty

Well, not if US lawmakers have anything to say about it. In a bipartisan vote the House of Representatives signed a letter urging leadership to keep the cash accounting method for tax purposes. Along with reform of the tax code, there have been rumblings of changing to the accrual basis of accounting for more businesses. This change would have a major impact on many companies that are using cash basis to keep their books and records.

In the letter the group of Senators state:

“The basic tenet of taxation is ‘ability to pay.’ Forcing businesses to recognize income before they receive payment violates this basic tenet…the acceleration of the business’ tax liability combined with the inability to match revenues with expenses would force businesses to borrow money to meet their tax liability”

This argument is interesting to me because the basic tenet of the accrual method is to accelerate expenses and defer revenue until it is earned. For example, your company receives professional services in the 4th quarter and fees are due on completion. In the cash basis of accounting you wouldn’t expense anything until cash goes out the door, but for accrual you would expense these services in the 4th quarter. If anything, the acceleration of expenses would be a tax benefit to businesses, which is conveniently left out of the Senators’ letter. I understand their argument in the case of the service industry, as oftentimes you are paid after services are complete. But, if you are paying taxes months after year-end and still can’t collect a percentage of your cash, you may have larger issues as a company.

Briefly mentioned, but the seemingly better argument is related to the administrative burden this would put on a businesses. Accrual accounting is much more complex than its basic cash counterpart. Cash basis is easy to understand for any business owner because everything is based on cash inflows and outflows. Accrual basis requires much more diligence in the accounting/finance function of your business because you have to account for items that will reasonably exist in the near future. This does not seem to jive with the notion of simplifying the tax code.

Another interesting aspect of this letter is the endorsement by the AICPA, usually the organization is pro any new legislation that adds complexity and creates jobs in the accounting industry (see SOX compliance).

I guess I shouldn’t be shocked that Congress doesn’t completely understand accounting principles, but it appears the letter has at least given additional attention to keeping cash basis of accounting for tax purposes.

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Chris Sluty

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