Whether you use the accrual or cash accounting method determines the time at which you recognize your revenues and expenses. The accounting method you choose may affect the amount of taxes you have to pay at any given year. As an S corporation, you may be able to use either one of the two methods.
Accrual Accounting
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With the accrual accounting method, you record your revenues and expenses in the year you incur them. For example, if you purchase a piece of business equipment on credit, you may only have to pay the money next year. However, you have to report the purchase this year and consider it this year's expense. The same principle goes for revenues. If you sell something on credit, you have to record the revenue in the year of the sale and not in the year during which you receive the money.
Cash Accounting
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Individuals and small businesses often choose the cash accounting method over the accrual method, according to the Internal Revenue Service. With the cash method, you record your revenues and expenses in the year you actually pay out or receive the money. If you were to purchase a piece of equipment like in the previous section's example, you would only have to record the expense next year when you pay the supplier, even though you receive the item this year. If you sell something on credit, you also only recognize the income when you receive the money.
Company Structure
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A corporation generally has to use the accrual accounting method for tax purposes if its gross receipts amount to more than $5 million. The corporation, therefore, may find that it can use the cash method for the first few years, but has to change to the accrual method as it grows. As an S corporation, you may be able to choose between the accrual and cash accounting methods, regardless of the size of your company or the amount of your income.
Company Inventory
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As an S corporation, you can use either the accrual or cash accounting method if you don't keep an inventory. If you maintain an inventory, you have to use the accrual method. The IRS considers an inventory to be items you produce, purchase or sell to generate income. As such, you have to use the accrual method if you wholesale, manufacture or sell products. If you sell services; for example, if you are a doctor, you may use either the cash or accrual method because the IRS considers the items you need to be supplies.
