The choice of accounting method for a business can determine whether the company is appropriately valuated and whether the proper taxes will be paid. The Internal Revenue Service (IRS) recognizes four accounting methods. These include accrual, cash, special and hybrid. The two most common methods are accrual and cash. The special and hybrid methods are used for alternative accounting in special circumstances.
The first special method of alternative accounting is used for farmers. Farming involves managing or cultivating a farm for profit as either an owner or tenant. Farmers have the option of using the crop accounting method. This method needs IRS approval and can be used if the farmer does not harvest or dispose of the crop in the same year it is planted. This method allows for the deduction of the cost of producing the crop in the year it is sold.
Another special method of alternative accounting includes installment sales. Installment sales occur when customers pay for a purchased item over time and at least one payment occurs after the tax year in which the item was sold. The installment sales method of accounting allows for each payment to be recorded as income for that tax year. Installment sales need to be properly documented for IRS review.
A final special method of alternative accounting works with depreciating property. Depreciating property allows for the recovery cost of business property or income-producing property through tax deductions. There are four depreciating accounting methods that can be used. These include a 200 percent declining balance, a 150 percent declining balance and a straight-line method over a general or alternative depreciation system. Taxpayers must use the general depreciation system for property used 50 percent or less in the business.
The hybrid method of accounting involves the use of a combination two of the other accounting methods to determine the business's income. The combination can include any of the special methods or the cash or accrual method. The hybrid method is allowed by the IRS when the combination clearly shows the income and it is used consistently. It is important to note that any hybrid method that includes the cash method will be considered the cash method of accounting.