Academic journal article Journal of Accountancy

The Accrual Basis Trap

Academic journal article Journal of Accountancy

The Accrual Basis Trap

Article excerpt

Many small companies that use the cash basis of accounting for tax purposes should be careful to avoid slipping into the accrual basis because of oversights in reporting. Companies should be particularly careful when reporting inventory, accounts receivable and accrued expenses. For example, inventory used for producing income that is purchased for resale and that is a significant share of the cost of goods sold most probably will qualify a taxpayer for the accrual basis of accounting.

In recent years, the Internal Revenue Service has sought through rulings and cases to ensure that taxpayers properly use the cash basis. In private letter ruling 9524001, the IRS required a general construction contractor to use the accrual basis because the construction materials it acquired and sold were inventory. Internal Revenue Code section 1.446-1(c)(2) mandates the use of the accrual basis for companies required to have inventory. The ruling also refers to IRC section 1.471-1, which provides for the use of inventories whenever a company's production, purchase or resale is income producing. …

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