Accrual accounting is an accounting method used by many businesses. This method recognizes revenues and expenses as of the date they occur. This method offers advantages in some ways, but in other ways there can be drawbacks.
Under the accrual method, businesses have no leeway in paying taxes. This method states that revenue is recorded as soon as it is earned. The date a business actually receives payment for the sale has no effect on the books other than to record the receipt of cash.
Because revenue is recognized on the date it is earned, a company may end up paying more in taxes for the year than what it actually received in payment.
If a company completed several large jobs at the end of the year but did not receive payment for them until February, the total amount of sales is still recorded in the year they were earned. This causes the company’s revenue to exceed what was expected, therefore causing a higher net income for the business and a larger tax liability.
Business owners can avoid this problem near the end of the year, if possible, by not billing or shipping goods until the first day of the following year.
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