“I haven’t collected payments from my customers. Why should I pay the sales tax now? It is unfair!” Business owners are often confused because they don’t understand the sales tax rules are based on accrual accounting.Accrual basis and cash basis are two principal methods of keeping track a business’s income and expenses. Under accrual basis accounting, revenue is recorded as it is earned, and expenses are deducted as they are incurred – whether they are paid or not. Under cash basis accounting, revenue is not counted until cash is actually received and expenses are not counted until they are actually paid.
Here is an example. Joe, the plumber, did a project for $5,000 for one of his clients. He invoiced his client on November 25 and received a cheque for the payment on December 20. In order to do the project, he spent $1,000 material and paid all the bills in November. Joe took a long vacation in December and did not do any projects. Under accrual accounting, revenue was $5,000 and expenses were $1,000 in November. So Joe made a net profit of $4,000 in November. Revenue and expenses are zero in December. So the net profit is zero in December. Under cash accounting, revenue was zero and expenses were $1,000. So Joe incurred a loss of $1,000 in November. Revenue for December is $5,000 and expenses were zero. So Joe made a profit of $5,000 in December.
The two methods differ only in the timing of when transactions are recorded. But financial statements will show different pictures under these two different methods.
