Accrual method reports the revenues in the period in which they are earned and expenses are reported in the period in which they are incurred in an attempt to produce revenues. For example, revenue would be recognized when the supplies are used and not when the cash is paid for the supplies purchased. The accrual basis of accounting requires the use of an adjusting process at the end of the accounting period to match revenues and expenses for the period properly. The matching principle is closely liked to accrual accounting and to revenue recognition. The matching principle states that to determine the earning of a company for an accounting period the total expenses involved in obtaining the revenues for that period must be computed and related to (matched against) the revenues recorded in the same period. The intent is to match the sacrifices against the benefits – that is the efforts against the accomplishments – in the appropriate accounting period.
You generally include an amount as income for the fiscal year or the tax year in which the income has been generated, or in which your income was made. You should be able to report this with out much difficulty. However, it is truly very useful to use this method of accounting in our Agricultural World.
With the accrual method, you must use an inventory to figure your gross income. These show increases in inventory values of livestock, produce, feed, etc., between the beginning of the year and the end of the year. A complete inventory of these items is required for reporting income on an accrual method.
To figure gross income on an accrual method you should do the following:
- 1) Add the following items:
- a. proceeds from the sale during the year of all livestock and livestock products, such as milk
- b. inventory value of livestock and products not sold at the end of the year
- c. miscellaneous items of income you earn during the year such as breeding fees, fees from renting or leasing animal machinery, or land, or other incidental farm income
- d. subsidy or conservation payments received that are considered income
- e. gross income from all other sources
- 2) Then subtract the total of the following items:
- a. inventory value of the livestock and products you had on hand at the beginning of the year cost of any livestock or products you purchased during the year including livestock held for draft, dairy or breeding purposes if they are included in inventory. Do not subtract their cost unless they are included in the inventory
These are generally deducted or capitalized as an expense in the tax year in which the following apply:
- 1) The all-events test has been met
- a. all events have occurred that fix the fact of liability and
- b. the liability can be determined with reasonable accuracy
- 2) Economic performance has occurred
Generally you cannot deduct or capitalize a business expense until economic performance occurs. If expense is used for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used.
Some small companies do not use accrual accounting and matching. Instead they use cash basis accounting. In cash basis, which is generally what the Ag community uses, the earning of a company for an accounting period are computed by subtracting the cash payments from the cash receipts for an operation. This method may lead to incorrect evaluations of a company’s operating results because the receipt and payment of cash may occur much earlier or much later than the actual sale of the goods or the providing of the services to their customers (benefits) and the related costs (sacrifices).