In: Accounting
Discuss the significance of accounting methods regarding the determination of taxable income. Make sure that you address the types of available accounting methods, whether a taxpayer can choose a method, and why it matters.
Normally we see that there are two accounting method for calculating taxable income. These methods are receipts method (cash basis method) and accrual method. Now let’s discuss these two methods in detail;
Cash method;
Under this method taxable income is calculating on the basis of actual receipts and actual expenditures. In other words we can say that under this method taxable income is calculated on the basis of (Actual receipts – Actual expenditures). Hence as per this method whatever receipts and whatever gone out is considered for calculated taxable income during a accounting year.
Accrual method;
Under this method taxable income is calculating on the basis of actual income earned for a particular accounting period and actual expenditures incurred for that accounting period. Hence how much is actually received and how much is actually paid does not matter. Thus it is totally based on accrual concept.
Yes it is true that a taxpayer can choose any accounting for calculating own tax liability because overall it will result into same tax liability in long-term but change in accounting method can be done with the help of tax authorities. So it is clear that taxpayer can calculate taxable income with help of any available accounting method.
This is also true that each method will result into some difference in taxable income in a particular year because it is quite possible that as per cash method taxable income may be higher in a particular accounting year or vice versa. Hence it is true that selection of any accounting method may lead to some differences in taxable income for a particular accounting year only because overall in long-term it will be automatically equals with each year.