Question

Imagine you have decided to change the accounting method you chose after three (3) years in business, as you have discovered that another method would be more advantageous from a tax perspective. Analyze the rules regarding changes in accounting methods and then create a table that illustrates the effect of changing the accounting method on three (3) of your business’ unique transactions. 

Answer 1

Neither the Code nor the regulations specifically define the term "method of accounting." In general, an accounting method is a set of rules used to determine when and how a taxpayer takes income and expenses into account for federal income tax purposes
A taxpayer must compute taxable income under the method of accounting regularly used in keeping its books. However, the regulations allow variations between financial and tax reporting where the method of accounting used for tax complies with the requirements of the IRC and the regulations and provides a clear reflection of taxable income (e.g., depreciation). The taxpayer must be able to reconcile any variations between book and tax accounting
Below points should be considered in case of change in accounting policies:
Clear Reflection of Income: If a taxpayer has not used a method of accounting regularly or if the method employed does not clearly reflect income, the Service will make the computation under a method that, in the opinion of the Commissioner, clearly reflects income.
Timing: A change in the method of accounting includes a change in the overall plan of accounting, as well as a change in the treatment of any material item. A material item is any item that involves the proper time for inclusion of the item in income or the taking of a deduction.
Consistency: Although a method of accounting may exist without a pattern of consistent treatment of an item, a method of accounting is not established in most instances without consistent treatment.
Errors and Changes in Underlying Facts: A change in method of accounting does not include correction of mathematical or posting errors, or errors in the computation of tax liability (such as errors in computation of the foreign tax credit, net operating loss, percentage depletion, or investment credit). Likewise, a change in method of accounting does not include a change in treatment resulting from a change in underlying facts
Effect on change in Adjusting period:
Company Z, a calendar-year corporation, has a net positive section 481(a) adjustment of $320,000 at the end of 20X1. If Company Z initiates a change in its accounting method under revenue procedure 97-27 for the 20X2 tax year, the company will recognize one-fourth of the 481(a) adjustment in the four succeeding years, starting with 20X2. However, if Company Z is under examination for 20X1 and the IRS makes an accounting change adjustment, the entire section 481(a) adjustment will be taxable in the year of examination.
	Taxable Income
Year	IRS	Company
	Initiates Change	Initiates Change
20 X 1	$320,000	-
20 X 2	-	$80,000
20 X 3	-	$80,000
20 X 4	-	$80,000
20 X 5	-	$80,000
	$320,000
Change in Cash Vs Accrual basis
If a company called, say, Cash Method Company, pays its annual rent of $12,000 in January, rather than paying $1,000 per month all year, it will show a rent expense of $12,000 in January and no rent expense for the rest of the year. If another organization, Accrual Method Company, made the same rental payment in January, its records would show a $1,000 rent expense in January as well as in each month of the year
CHANGING ACCOUNTING METHODS
Changes in accounting methods generally result in adjustments to taxable income, either positive or negative. For example, say a business wants to change from the cash basis to the accrual basis. It has accounts receivable (income earned but not yet received, so not recognized under the cash basis) of $15,000, and accounts payable (expenses incurred but not paid, so not recognized under the cash basis) of $20,000. Thus the change in accounting method would require a negative adjustment to income of $5,000.
Note-
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