Accounting Period & Change In Accounting Method

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ACCOUNTING PERIOD CHANGE IN ACCOUNTING METHOD
The business operations of any organization
depend a lot on the accounting method and
accounting period they choose. In this blog, we
will take a detailed look at these two important
points.
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WHAT ARE THE DIFFERENT TYPES OF ACCOUNTING
PERIODS?
CALENDAR YEAR
As the name suggests, its a year that starts
from January 1st and ends on 31st December.
Generally, sole proprietorships, partnerships,
personal service corporations, and S Corporations
opt for this year. In some cases, with special
permission from the IRS, they can use a different
period, especially useful for those managing
Accounting Services.
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FISCAL YEAR
A fiscal year is commonly used by seasonally
operated businesses. Its made up of 12
consecutive months, except December.
SHORT TAX YEAR
Short tax year is the the period of less than 12
months. Its used during the year when a
particular business is formed, dissolved or the
accounting period is changed.
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52-53 WEEK TAX YEAR
An entity can choose this tax year that ends on
the same day of the week each year. This may or
may not correspond to the last day of a calendar
month. Businesses typically opt for the closest
date to the end of the month.
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HOW TO CHOOSE YOUR ACCOUNTING PERIOD?
A business has to file its tax return in the
period it wants to set its accounting period. But
if a business wants to change its accounting
period, it can fill the Form 1128. This is an
application form to Adopt, Change, or Retain a
Tax Year. Once the IRS approves this application
form, the business can change its accounting
period. The change in the accounting period could
be the result of restructuring, incorporation, or
alignment with industry standards.
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ACCOUNTING METHODS
CASH METHOD
This is the most simple accounting method,
especially suited for Small Business Accounting.
In this method, revenues and expenses are noted
at the time cash is received or paid. It is
highly intuitive as it involves actual cash
flows. The best part? It does not require
tracking receivables or payables. It offers
simplicity and a clear view of how much cash the
business actually has on hand at any given time.
Small businesses and individual proprietors often
prefer this method because it is easier to
maintain and there is no need to track money that
is owed or owing.
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However, the Cash Method can provide a misleading
picture of longer-term financial health. Since it
records transactions only when cash changes
hands, it can show a business to be highly
profitable in one period (when receiving
prepayments) and less profitable later when the
cash inflows are lower. So despite its
simplicity, this method may not deliver accurate
financial condition of the business. The main
reason is, that it does not consider debts and
receivables into account. Example Using the
same landscaping business scenario, under the
accrual method, the 5,000 received on June 30th
is recorded as unearned revenue, and only 1,000
(one-fifth of the total for one month of service)
is recognized as income in June. The remaining
4,000 will be recognized as income over the next
four months. Similarly, if the lawnmower was
delivered and used starting in June but paid for
in July, the expense would still be recorded in
Junes financial records because thats when the
asset began to be used in the service provision.
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ACCRUAL METHOD
Conversely, the Accrual Method provides a more
comprehensive portrayal of a companys financial
status. This method records income items when
they are earned and expenses when they are
incurred, regardless of when cash transactions
occur. This approach aligns expenses with related
revenues in the same accounting period, which
adheres to the matching principle of accounting
a cornerstone of accrual accounting.
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This method is more complex as it requires
maintaining detailed records of all credit
transactions and the status of all receivables
and payables. It is more labor-intensive than the
cash method but provides a more accurate
financial picture, especially for larger
companies or those with a lot of credit
transactions. It allows businesses to forecast
financial trends more effectively and prepare
more comprehensive financial statements, which
are crucial for attracting investors or obtaining
loans. Example Using the same landscaping
business scenario, under the accrual method, the
5,000 received on June 30th is recorded as
unearned revenue, and only 1,000 (one-fifth of
the total for one month of service) is recognized
as income in June. The remaining 4,000 will be
recognized as income over the next four months.
Similarly, if the lawnmower was delivered and
used starting in June but paid for in July, the
expense would still be recorded in Junes
financial records because thats when the asset
began to be used in the service provision.
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HYBRID METHOD
The Hybrid Method combines elements of both cash
and accrual accounting and is used by businesses
that prefer the flexibility to tailor the
accounting methods to different types of
transactions. Typically, this method uses the
accrual approach for inventory and other
significant assets while employing the cash
method for income and expenses, providing a
middle ground between the operational simplicity
of the cash method and the comprehensive detail
of the accrual method.
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This method can be particularly beneficial for
businesses that manage a large inventory but do
not want to employ full accrual accounting for
all operations. By using accrual accounting for
inventory, businesses can accurately track the
cost of goods sold and inventory levels, which is
important for producing accurate financial
statements. Meanwhile, using the cash method for
other transactions reduces the complexity and
maintenance of the accounting system. Example
Imagine a business that sells both services and
products. It uses the accrual method to account
for product sales and inventory but uses the cash
method for its service revenue and associated
expenses. If it receives an advance of 3,000 in
June for a consulting project to be conducted
over the next three months, this amount is
recorded as revenue in June itself (cash method).
Conversely, if it sells 2,000 worth of products
in June but wont receive payment until July, the
2,000 is still recorded as June revenue (accrual
method). Expenses are handled in a similar mixed
approach depending on their nature.
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CHOOSING AND CHANGING THE ACCOUNTING METHOD
Businesses select their accounting method when
they file their first tax return. To change the
accounting method afterward, they must file Form
3115 (Application for Change in Accounting
Method) and obtain consent from the IRS. This
might be necessary to more accurately reflect
earnings or to comply with tax laws as the
business grows and evolves.
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CASE STUDIES AND PRACTICAL IMPLICATIONS
SCENARIO ANALYSIS

• A corporation might switch from a cash to an
  accrual basis as it expands to better match
  income with the expenses incurred in earning it.
  This provides a more accurate financial picture.
• A sole proprietor might start with a calendar
  year. But then switch to a fiscal year to align
  better with business cycles, especially if the
  business is highly seasonal.

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BUSINESS CONSIDERATIONS

• Regulatory Requirements Certain businesses are
  required by law or industry standards to use
  specific accounting methods. For instance,
  corporations with revenues above a certain
  threshold must use the accrual method.
• Tax Implications Choosing the wrong accounting
  method or period can lead to significant tax
  implications, including deferred tax liabilities
  or accelerated tax obligations.
• Financial Reporting Accurate financial reporting
  helps in attracting investors, manage finances,
  and make informed business decisions. The choice
  of accounting method can significantly impact
  reported earnings, asset valuation, and
  investors' perception.

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WRAPPING UP
The decision on which accounting period or method
is important for financial reporting and tax
obligations of a business. Businesses should
carefully consider the business type, industry
standards, and regulatory requirements before
picking an accounting method. It requires careful
consideration of the business type, industry
standards, regulatory requirements, and financial
reporting needs. And if you have any doubts or
confusion, our experts at CROWGNLOBE are here to
help. You can always reach out to them for
assistance. Every year, we assist a lot of
businesses with choosing the right accounting
year and the right accounting method.
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CONTACT
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COM 7901 4TH ST N STE 300, ST PETERSBURG FL 33702