QuickBooks is a popular software program for small business accounting. When you set up a new business in QuickBooks, you are asked if you want to use the "cash" or "accrual" method of accounting. Both methods of accounting are acceptable for income tax reporting to the Internal Revenue Service. While it is possible to change methods in QuickBooks, it is difficult to change accounting methods with the IRS. However, you can easily obtain reports from QuickBooks for either method by just changing a report's preference whenever you want.
The accrual accounting method accounts for items at the moment of the transaction. For instance, an invoice is considered income the moment it is written. If you complete an invoice on December 31, it is considered income for that year even if payment is not received until the following year. Insurance is considered a prepaid asset that is expensed monthly throughout the life of the policy. If you pay for an annual policy, you will need to set up a pre-paid insurance account in QuickBooks. Each month you will make a general ledger entry to transfer the cost of one month's worth of insurance from the asset to the expense column of your ledgers.
In a cash accounting system, an invoice is not considered income until you receive the money from your customer. An invoice that is sent on December 31 and paid for on January 5th would be considered income in the new year. The check to pay for the year of insurance would be a single expense entry. There would not be a recorded asset for the insurance.
Changing Between Accounting Methods for Reports
In QuickBooks, you may need to have your accrual report displayed as a cash report to have a better understanding of where your business stands, as in accounts receivable. It is a simple matter of changing preferences under the summary report to display the different accounting option. The same is true in reverse: A cash report in QuickBooks can be changed to reflect the accrual method of accounting without changing your overall bookkeeping system.
For income tax purposes, determine your best accounting method when you set up your bookkeeping system and maintain that system. The IRS understands that a business may need to change accounting methods over the life of the business, but changing the accounting method every year will send a red flag, and your chances for an audit will increase.