Methods Of Accounting - CrownGlobe

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METHODS OF ACCOUNTING
For business, its very important to pick a
perfect accounting method. So its importance to
make the right choice. Reason? The method you
pick can impact your financial statemetns and tax
obligations. The main accounting methods are the
Cash Method, Accrual Method, Special Method, and
Hybrid Method. In this blog, we will take a look
at these primary methods.
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CASH METHOD
This is the simplest accounting method. In this
method, the income is recorded when received, and
expenses are recorded when they are paid. Its
most suitable for individuals and small
businesses as it is super simple and demands a
lot less record-keeping. Under the Cash Method,
gross income includes all items actually or
constructively received during the tax year.
Constructive receipt occurs when an amount is
credited to the taxpayers account or made
available without restrictions. For example,
income received by an agent on behalf of the
taxpayer is considered received by the taxpayer
when the agent receives it.
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Expenses are deducted in the tax year when they
are paid. However, prepaid expenses are generally
deductible only in the year to which they apply
unless they qualify for the 12-month rule. This
rule allows expenses to be deducted in the year
paid. But only if the benefit does not go beyond
the earlier of 12 months after the first date on
which the taxpayer realizes the benefit or the
end of the tax year following the tax year in
which the payment is made.
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ACCRUAL METHOD
The Accrual Method records income when earned.
Similalrly, it records expenses when incurred.
Both of these steps are taken regardless of when
cash is received or paid. This method provides a
the perfectly accurate picture of a companys
financial position.
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• Income is reported in the year it is earned. This
  includes amounts earned but not yet received. The
  earliest of the following dates is used to
  determine the income reporting year
• When the income is earned.
• When the payment is received.
• When the income is due.
• When the title passes to the taxpayer.
• Expenses are deducted in the year they are
  incurred, meeting the all-events test and
  economic performance test. The all-events test is
  met when all events have occurred that fix the
  liability, and the amount can be determined with
  reasonable accuracy. The economic performance
  test is met when the underlying activity occurs,
  such as the delivery of goods or services.

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SPECIAL METHOD OF ACCOUNTING
The Special Method of accounting applies to
certain items that require specific treatment,
ensuring the correct matching of income and
expenses within the relevant period. This method
is particularly relevant for long-term contracts,
installment sales, and specific types of
inventories. Each of these areas necessitates a
unique approach to recognize income and expense
correctly. For long-term contracts, the
Percentage of Completion Method and the Completed
Contract Method are commonly used. The Percentage
of Completion Method recognizes revenue and
expenses proportionally to the work completed
during the accounting period.
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This method is preferred when the outcome of the
contract can be reliably estimated. It ensures
that the income is matched with the expenses
incurred to achieve that income, a more accurate
reflection of the companys financial performance
over the contracts duration. The Completed
Contract Method, on the other hand, recognizes
revenue and expenses only when the contract is
completed. This method is simpler but may not
always provide a timely representation of the
financial status of projects spanning multiple
accounting periods. In installment sales, the
installment method is used to recognize income as
payments are received. This method defers the
recognition of income until cash is actually
collected, spreading the tax liability over the
period the payments are received rather than
recognizing the entire gain at the point of sale.
This method could prove to be extremely useful
for businesses that sell high-value items on
credit. For example, real estate or expensive
equipment. This allows them to match income with
cash flow more accurately. Certain inventories
may also require special accounting methods. For
example, the Retail Method can be used to
estimate the ending inventory and cost of goods
sold based on the relationship between the cost
and the retail price of inventory items. This
method is useful for businesses with a large
volume of merchandise where tracking individual
items might be impractical.
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HYBRID METHOD OF ACCOUNTING
The Hybrid Method of accounting combines elements
of both the Cash and Accrual Methods, allowing
for a more tailored approach to financial
reporting. This method is particularly beneficial
when different transactions within the same
business require different accounting
treatments. Under the Hybrid Method, a business
might use the Cash Method for most of its
transactions, recording income when received and
expenses when paid. This approach simplifies the
accounting for many routine transactions.
However, for items like inventory, the business
would record income when earned and expenses when
incurred.
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This combination ensures that the financial
statements reflect the true economic activity of
the business. For example, a retail business
might use the Cash Method for its sales
transactions but apply the Accrual Method for
inventory purchases. By doing this, the business
can manage its cash flow effectively. Similalry,
this also ensures that the cost of goods sold is
matched with the related sales revenue. This
method gives a better and more accurate idea
about profitability, particularly in businesses
where inventory plays a significant
role. Businesses that engage in long-term
contracts can also benefit from Hybrid Method.
The revenue and expenses from these contracts can
be used for the Percentage of Completion Method,
while other transactions follow the Cash Method.
Such a flexibility allows businesses to meet
their specific financial need. The best part?
They can do so without compromising the accuracy
and reliability of their financial statements.
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BOOKKEEPING SYSTEMS
The Hybrid Method of accounting combines elements
of both the Cash and Accrual Methods, allowing
for a more tailored approach to financial
reporting. This method is particularly beneficial
when different transactions within the same
business require different accounting
treatments. Bookkeeping systems are essential for
maintaining accurate financial records. The two
primary systems are Single-Entry and Double-Entry.
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• Single-Entry System Uses cash receipts and
  disbursements and is built around the income
  statement.
• Double-Entry System Uses journals and ledgers,
  based on the income statement and balance sheet,
  and is self-balancing. This system records every
  transaction as both a debit and a credit,
  ensuring accuracy and completeness.

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WRAPPING UP
When you select an accounting method, its very
important to weigh in all the factors. Reason? If
you pick a wrong method, your entire accounting
and financing goes haywire. Moreover, each method
has specific rules and applications, and the
choice depends on the nature of the business and
regulatory requirements. Proper bookkeeping
practices support the chosen accounting method,
ensuring accurate and reliable financial
information. All this can feel overwhelming, and
thats totally understandable. So, if you need
any assistance with accounting method selection
or accounting services, our experts at CROWNGLOBE
can help. Feel free to reach out to us.
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