Determining your Accounting Method

• When you set up your bookkeeping system, you need to determine which accounting method you'll use to record income and expenses. You'll also need to declare the accounting method on line F of Schedule C of the first federal income tax return you file for your business. If you don't make a declaration, you are assumed to be a cash-basis taxpayer. This means you only record income and expenses when they are actually received or paid. To change accounting methods, you must obtain permission from the Internal Revenue Service by filing form 3115, an "Application for Change in Accounting Method."
  
  

Cash Basis Accounting for an Invoice

• If you've elected cash basis accounting, when you send an invoice to a customer, you'll enter it as a "pending sale" or "accounts receivable" instead of an actual sale. Once the invoice is actually paid by the customer, you'll record it as a sale and remove the amount from accounts receivable.
  
  

Accrual Method Accounting for an Invoice

• If you've elected the accrual method of accounting, when you invoice a customer, you'll record it as a sale right away. The accounting entry is to credit sales and debit accounts receivable. When the customer actually pays the invoice, the accounting entry is to debit cash and credit accounts receivable so that accounts receivable then has a zero balance.
  
  

Planning

• Accrual method accounting gives you more control of the income and assets you report on your financial statements. For example, if you want to defer sales until the next year, you won't issue an invoice to the customer until the following year. When you're using the cash basis method, you must record the income when you receive it; therefore your income is based directly on the paying habits of your customer. In some instances, an accrual method might be advantageous, because you have large business deductions and want to record the income as soon as possible so the income can be offset by the deductions.