Types of Accounting Methods

An Accounting method is a set of rules used to determine when and how income and expenses are reported. A taxpayer may choose any method however the method must properly reflect income and expenses accurately and the mtehod must be consistent year over year. A business can change the accounting method by using Form 3115, Application for Change in Accounting Method if they want to change from cash basis to accrual basis or vice versa. Accrual Method is used by large corporations and is considered a more accurate method of accounting. Following are the most common methods of accounting:

Cash Method: Simplest method of accounting used by most businesses. Cash method however cannot be used by tax shelters or a business whose average sales for the past three years exceed 30 million. Under Cash method, a business deducts expenses as they are paid. However a business cannot pay several years in advance a future expense to lower their current tax liability. Under the cash method, the business reports income when it is actually or "constructively" received. 

Accrual Method: Under Accrual method, a business generally records income when a sale occurs or income is earned regardless of when the business gets paid. The accrual method gives a more accurate picture o business compared to cash basis. Expenses under this method are reported as incurred, and not when actual payments are made. 

Special method of accounting for certain items of income and expenses OR The Hybrid method (using elements of the above method): A business may also use a hybrid accounting method that combines the Cash Method, Accrual Method or other special methods as long as the hybrid method clearly reflects income and is used consistently. However if inventory is necessary to account for income, and the business does not qualify as a "small business", the business must use the accrual method for purchases and sales. The cash method can be used for other income and expense items. In addition, if an entity uses the cash method for reporting income, it must use cash method for reporting expenses. Also, if a business uses the accrual method for reporting expenses, it must use the accrual method for reporting income.