Accrual Balance Sheet Mixed With Cash Basis Income Statement

Posted by W on September 26, 2009, 2:39 am

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I have an interesting situation with a S-Corporate return prepared by an
accountant. The company keeps its books in Quickbooks, and they do their
accounting and report taxes on a cash basis. The accountant is taking the
position that Quickbooks' cash-basis balance sheet incorrectly shows entries
for Accounts Receivable and Accounts Payable - which are strictly speaking
Accrual concepts. So he is preparing the return as follows:

1) He takes the Accrual balance sheet from Quickbooks and enters that in
Schedule L

2) He takes the cash basis income statement from Quickbooks and enters that
in the income part of the return

3) He then reconciles the accrual to cash conversion of net income with a
line in Schedule M-1

While it might be a purer way to do things, it does make it harder to verify
the return, and requires some extra work for the company.

My questions are:

1) Does anyone see a problem with preparing the return this way?

2) Is there a strong reason to not just use the Quickbooks' cash-basis
balance sheet, and just allow it to include the Accounts Payable and
Accounts Receivable entries? It would certainly make it easier to read and
verify the return against the books. And from what I understand the IRS
doesn't pay much attention to Schedule L in any case, so probably the
cash-basis balance sheet would pass.

--
W

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Posted by Gene E. Utterback, EA, RFC, AB on September 29, 2009, 2:40 pm

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>I have an interesting situation with a S-Corporate return prepared by an

>accountant. The company keeps its books in Quickbooks, and they do their

>accounting and report taxes on a cash basis. The accountant is taking

>the position that Quickbooks' cash-basis balance sheet incorrectly shows

>entries for Accounts Receivable and Accounts Payable - which are strictly

>speaking Accrual concepts. So he is preparing the return as follows:

> 1) He takes the Accrual balance sheet from Quickbooks and enters that in

> Schedule L

> 2) He takes the cash basis income statement from Quickbooks and enters

> that in the income part of the return

> 3) He then reconciles the accrual to cash conversion of net income with a

> line in Schedule M-1

> While it might be a purer way to do things, it does make it harder to

> verify the return, and requires some extra work for the company.

> My questions are:

> 1) Does anyone see a problem with preparing the return this way?

> 2) Is there a strong reason to not just use the Quickbooks' cash-basis

> balance sheet, and just allow it to include the Accounts Payable and

> Accounts Receivable entries? It would certainly make it easier to read

> and verify the return against the books. And from what I understand the

> IRS doesn't pay much attention to Schedule L in any case, so probably the

> cash-basis balance sheet would pass.

> --

> W

Sounds to me like it is essentially being done correctly. The M-1
adjustment you speak of is an Accrual to Cash Conversion entry and it does
go on the M-1. Though it may not stop there, especially depending on the
tax software being used.

Small companies frequently use one method for their books and a second
method for taxes, there is nothing wrong with this at all. The Accrual to
Cash Conversion entry should be pretty straight forward and should NOT make
it any harder to verify the return. The M-1 is itself a BOOK TO TAX
Reconciliation and you should be able to trace all the numbers directly
there.

Personally, I usually expand on the Accrual to Cash Conversion -

1 - I start with income (that matches the balance sheet - if you're using an
accrual balance sheet I would use an accrual income statement) and back out
this year's A/R and add back last year's A/R;
2 - on the Tax Schedule for Other Deductions I back out this year's A/P and
add back last year's A/P;
3 - on the M-1 I list all four numbers, current and prior year A/R and A/P -
but only so the detail is there for the client to see.

Since this is an S corp. you may have some other issues to deal with like
stock and or loan basis. Some tax programs also don't seem to correctly
deal with the differences between Retained Earnings and the Accumulated
Adjustments Account - these are NOT the same and often show different
numbers (even if the entity has been an S Corp from day 1).

Hope this helps,
Gene E. Utterback, EA, RFC, ABA

--
<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>

Posted by Richard Di Bernardo, CPA on October 12, 2009, 10:50 am

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Richard Di Bernardo, CPA had written this in response to
http://www.rockryno.com/taxes/Re-Accrual-Balance-Sheet-Mixed-With-Cash-Basis-Income-State-23114-.htm
:

Richard Di Bernardo, CPA
-------------------------------------
Gene E. Utterback, EA, RFC, AB wrote:

>>I have an interesting situation with a S-Corporate return prepared

>> by an

>>accountant. The company keeps its books in Quickbooks, and they

>> do their

>>accounting and report taxes on a cash basis. The accountant is

>> taking

>>the position that Quickbooks' cash-basis balance sheet incorrectly

>> shows

>>entries for Accounts Receivable and Accounts Payable - which are

>> strictly

>>speaking Accrual concepts. So he is preparing the return as

>> follows:

>> 1) He takes the Accrual balance sheet from Quickbooks and enters

>> that in

>> Schedule L

>> 2) He takes the cash basis income statement from Quickbooks and

>> enters

>> that in the income part of the return

>> 3) He then reconciles the accrual to cash conversion of net income

>> with a

>> line in Schedule M-1

>> While it might be a purer way to do things, it does make it harder

>> to

>> verify the return, and requires some extra work for the company.

>> My questions are:

>> 1) Does anyone see a problem with preparing the return this way?

>> 2) Is there a strong reason to not just use the Quickbooks'

>> cash-basis

>> balance sheet, and just allow it to include the Accounts Payable

>> and

>> Accounts Receivable entries? It would certainly make it easier

>> to read

>> and verify the return against the books. And from what I

>> understand the

>> IRS doesn't pay much attention to Schedule L in any case, so

>> probably the

>> cash-basis balance sheet would pass.

>> --

>> W

> Sounds to me like it is essentially being done correctly. The M-1

> adjustment you speak of is an Accrual to Cash Conversion entry and it

> does

> go on the M-1. Though it may not stop there, especially depending on

> the

> tax software being used.

> Small companies frequently use one method for their books and a second

> method for taxes, there is nothing wrong with this at all. The Accrual

> to

> Cash Conversion entry should be pretty straight forward and should NOT

> make

> it any harder to verify the return. The M-1 is itself a BOOK TO TAX

> Reconciliation and you should be able to trace all the numbers directly

> there.

> Personally, I usually expand on the Accrual to Cash Conversion -

> 1 - I start with income (that matches the balance sheet - if you're

> using an

> accrual balance sheet I would use an accrual income statement) and back

> out

> this year's A/R and add back last year's A/R;

> 2 - on the Tax Schedule for Other Deductions I back out this year's A/P

> and

> add back last year's A/P;

> 3 - on the M-1 I list all four numbers, current and prior year A/R and

> A/P -

> but only so the detail is there for the client to see.

> Since this is an S corp. you may have some other issues to deal with

> like

> stock and or loan basis. Some tax programs also don't seem to

> correctly

> deal with the differences between Retained Earnings and the Accumulated

> Adjustments Account - these are NOT the same and often show different

> numbers (even if the entity has been an S Corp from day 1).

> Hope this helps,

> Gene E. Utterback, EA, RFC, ABA

I think that this procedure is inconsistent with IRC Sect 446(a):

§ 446. General rule for methods of accounting

(a) General rule
Taxable income shall be computed under the method of accounting on the
basis of which the taxpayer regularly computes his income in keeping his
books.

Line 1 of M-1 reflects "net income per books." If this reflects the
accrual method, then, according to the code, taxable income, likewise,
must also be computed with the accrual method.

Accrual to cash adjustments should not be booked in the schedule M-1.
These adjustments should be part of your "books." M-1 is "book to tax."

In this situation, I opine that the IRS can claim that the cash method is
an improper method of accounting.

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--
<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>

Posted by Gene E. Utterback, EA, RFC, AB on October 12, 2009, 3:15 pm

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> Richard Di Bernardo, CPA had written this in response to

http://www.rockryno.com/taxes/Re-Accrual-Balance-Sheet-Mixed-With-Cash-Basis-Income-State-23114-.htm

> :

> Richard Di Bernardo, CPA

> -------------------------------------

> Gene E. Utterback, EA, RFC, AB wrote:

>>>I have an interesting situation with a S-Corporate return prepared

>>> by an

>>>accountant. The company keeps its books in Quickbooks, and they

>>> do their

>>>accounting and report taxes on a cash basis. The accountant is

>>> taking

>>>the position that Quickbooks' cash-basis balance sheet incorrectly

>>> shows

>>>entries for Accounts Receivable and Accounts Payable - which are

>>> strictly

>>>speaking Accrual concepts. So he is preparing the return as

>>> follows:

>>>

>>> 1) He takes the Accrual balance sheet from Quickbooks and enters

>>> that in

>>> Schedule L

>>>

>>> 2) He takes the cash basis income statement from Quickbooks and

>>> enters

>>> that in the income part of the return

>>>

>>> 3) He then reconciles the accrual to cash conversion of net income

>>> with a

>>> line in Schedule M-1

>>>

>>> While it might be a purer way to do things, it does make it harder

>>> to

>>> verify the return, and requires some extra work for the company.

>>>

>>> My questions are:

>>>

>>> 1) Does anyone see a problem with preparing the return this way?

>>>

>>> 2) Is there a strong reason to not just use the Quickbooks'

>>> cash-basis

>>> balance sheet, and just allow it to include the Accounts Payable

>>> and

>>> Accounts Receivable entries? It would certainly make it easier

>>> to read

>>> and verify the return against the books. And from what I

>>> understand the

>>> IRS doesn't pay much attention to Schedule L in any case, so

>>> probably the

>>> cash-basis balance sheet would pass.

>>>

>>> --

>>> W

>> Sounds to me like it is essentially being done correctly. The M-1

>> adjustment you speak of is an Accrual to Cash Conversion entry and it

>> does

>> go on the M-1. Though it may not stop there, especially depending on

>> the

>> tax software being used.

>> Small companies frequently use one method for their books and a second

>> method for taxes, there is nothing wrong with this at all. The Accrual

>> to

>> Cash Conversion entry should be pretty straight forward and should NOT

>> make

>> it any harder to verify the return. The M-1 is itself a BOOK TO TAX

>> Reconciliation and you should be able to trace all the numbers directly

>> there.

>> Personally, I usually expand on the Accrual to Cash Conversion -

>> 1 - I start with income (that matches the balance sheet - if you're

>> using an

>> accrual balance sheet I would use an accrual income statement) and back

>> out

>> this year's A/R and add back last year's A/R;

>> 2 - on the Tax Schedule for Other Deductions I back out this year's A/P

>> and

>> add back last year's A/P;

>> 3 - on the M-1 I list all four numbers, current and prior year A/R and

>> A/P -

>> but only so the detail is there for the client to see.

>> Since this is an S corp. you may have some other issues to deal with

>> like

>> stock and or loan basis. Some tax programs also don't seem to

>> correctly

>> deal with the differences between Retained Earnings and the Accumulated

>> Adjustments Account - these are NOT the same and often show different

>> numbers (even if the entity has been an S Corp from day 1).

>> Hope this helps,

>> Gene E. Utterback, EA, RFC, ABA

> I think that this procedure is inconsistent with IRC Sect 446(a):

> § 446. General rule for methods of accounting

> (a) General rule

> Taxable income shall be computed under the method of accounting on the

> basis of which the taxpayer regularly computes his income in keeping his

> books.

> Line 1 of M-1 reflects "net income per books." If this reflects the

> accrual method, then, according to the code, taxable income, likewise,

> must also be computed with the accrual method.

> Accrual to cash adjustments should not be booked in the schedule M-1.

> These adjustments should be part of your "books." M-1 is "book to tax."

> In this situation, I opine that the IRS can claim that the cash method is

> an improper method of accounting.

> ##-----------------------------------------------##

> Newsgroup Access Courtesy http://www.rockryno.com/

> Tax and Accounting Software Forums

> Web and RSS access to your favorite newsgroup -

> misc.taxes.moderated - 23302 messages and counting!

You may opine all you like, using one method for tax and another for books
is an accepted practice that is supported by the code. However, I do NOT
have the citation in front of me and because of the date I am NOT going
looking for it.

I can assure you though, that this IS an accepted practice. Once we get
past 10/15 - and my doctor's appointments next week, I will try to remember
to get back to the group with the relevant citations, but I cannot promise
when I'll be able to do so.

Gene E. Utterback, EA, RFC, ABA

--
<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2007) - All rights reserved. >>
<< ------------------------------------------------------- >>