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STAR*TECH JOURNAL/JANUARY 1984
CASH OR ACCRUAL BASIS ACCOUNTING?
By Mark E. Battersby
One of the most basic questions faced by any
business is whether to operate using the cash
method or the accrual method of accounting.
To most coin-operated amusement operators,
simply recording the income received and
subtracting all purchases or expenditures
normally provides sufficient information to
determine profit or Joss. Unfortunately, the
Internal Revenue Service fears that such an
easy system could distort the income of the
amusement machine operator.
Under our tax laws, if income is realized
from the purchase, production or sale of mer-
chandise, inventories must be maintained in
order to properly reflect taxable income. This
means that the coin-op amusement operator
must use the accrual method of accounting for
purchases and sales - unless, of course, some
other method will clearly reflect income.
Because of the inventory requirement, most
of those in the coin-operated amusement
industry must use the accrual method of
accounting for purchases and sales. Ordinarily,
purchases for the year include all of those for
which goods ( or title to them) have passed into
the hands of the buyer during the year, whether
payment has been received or not.
The accrual basis does not have to be used
for other operating expenses, however. Nor
does it have to be used for non-operating
income and expense. For these the cash basis
method of accounting may be used But just
what is the" cash basis" method of accounting?
The cash-basis ( cash receipts and disburse-
ments method of accounting) is the method
used by most individuals. Under it, income is
reported for the year when it is actually or
constructively received, either in the form of
cash or its equivalent, or other property.
Deductions and credits are taken for the year in
which actually paid unless they should be
taken in a different period to more closely
reflect income ( examples would include capital
expenditures that must be depreciated and
prepaid expenses).
Because there is more control over income
and expenses under the cash basis, income and
expenses may to some extent be shifted from
one year to another ( at year's end) in order to
offset some of the variations in taxable income
and to save taxes over the years. Remember,
however, that an operator on the cash basis
cannot report income in a year other than that
in which it is received, even though he may
have to take deductions or credits in a year
other than that in which they were paid.
Under the accrual method, income is
accounted for when the right to receive it comes
into being; that is, when all of the events which
determine the right have occurred It is not the
actual receipt, but rather the right to receive
which governs.
When using the accrual method, expenses
are deductible in the year when all of the events
have occurred which fix the amount of the item
and determine the liability of the taxpayer to
pay it. If inventories are necessary to properly
reflect income, the accrual method of account-
ing must be used for purchases and sales as
already mentioned.
Obviously, accrual basis accounting is not
quite that cut and dried. What, for example, do
you do about sales returns and allowances? Or,
for that matter, when is a sale really and finally
a sale?
As mentioned, income from a sale is realized
by an accrual basis coin-operated amusement
operator at the time of the sale, whether or not
payment is received at that time, and by a cash
basis operator when he actually or construc-
tively receives payment. Similarly, sales on
credit must be reported at the time of the sale by
the accrual basis operator.
Ordinarily, a sale on open account is
completed when the item sold is delivered to
the buyer. But if title does not pass to the buyer
at that time, the sale is not complete and the
income would not normally be reported by
those using accrual accounting. Thus, in a so-
called "sale on approval" or a consignment
sale, the property is delivered to the buyer but
title does not pass at that time. In a sale on
approval, title passes when the buyer decides
to take the merchandise. In a consignment sale,
title passes only when the consignee sells the
goods.
Where the sale is made with the condition
that the buyer may return the merchandise if it
is not suitable or salable ( called a "sale or
return" by our lawmakers), title passes when
the merchandise is delivered Ifit is returned, it
is treated as a sales return.
Sales returns and allowances are deductible
from the total sales for the year. Sales returns
and allowances for the year should include
only those for which credit memos have been
approved and actually issued to the buyers.
In the case of a conditional sale, title does
not usually pass to the buyer until he has paid
all installments on the purchase price. But, at
least for income tax purposes, such a sale is
considered as complete when the item sold is
delivered to the buyer. The seller may legiti-
mately report those sales on the installment
method provided he is a dealer who regularly
sells on the installment plan.
Where it is expected that the seller's income
will be taxed at a lower rate in the next year
( either because of a reduction in tax rates or
because the amusement or service firm expects
to be in a lower tax bracket due to a smaller
estimated income from sales), he can save
taxes by deferring year-end sales until the next
year and by expediting the issuance of credit
memos on sales returns and allowances at the
year's end Naturally, the reverse would hold
true if the tax rates are expected to be higher or
the tax bracket higher in the next taxable year.
Fortunately, although all vending firms are
required to use inventories, some amusement
operators probably will not have to use the
accrual basis method of accounting, at least on
an overall basis. A coin-operated amusement
machine operation, for instance, where all
sales are for cash and where comparatively
small amounts of receivables and payables do
not vary to any great extent from year to year
would be able to use the cash basis. However,
he must increase or decrease his income by the
variation between the beginning and the ending
inventories.
A careful reading of our tax rules reveals
that it is not always necessary that money or
property representing income actually be in the
operator's possession before it is considered
received. Income constructively received is
taxed as though it had been actually received.
There is constructive receipt when income
is credited without restriction and made avail-
able to the operator. Common examples of
constructive receipt include matured and
payable interest coupons, interest credited on
savings bank deposits and dividends unquali-
fiedly made subject to a stockholder's demand
For those using either the cash or the
accrual method and who may wish to change,
the tax rules contain some bad news: permission
is necessary before changing accounting
methods. Surprisingly, it is even necessary to
secure permission before changing from an
unacceptable accounting method to an accept-
able method Changes in accounting methods
include:
- A change from the cash to the accrual
basis, or vice versa; or
- Any change in the method of valuing
inventories.
Any operator who voluntarily changes his
or her method of accounting with the IRS's
permission - or who is compelled to make a
change because the present method does not
clearly reflect income - must make certain
adjustments to income in the year of change.
The adjustments are those determined to be
necessary solely to prevent duplication or
omission of items.
Since adjustments for the year of change
might result in the bunching of income, two
methods of limiting the tax in the changeover
year are permitted If the amusement device
operator is to use the first of these methods, the
adjustments for the changeover year must have
increased taxable income by more than $3,000
and the old method of accounting must have
been used in the two preceding years.
Under the first method, the tax increase in
the changeover year is limited to the tax
increases that would result if the adjustments
were spread back ratably over that year and the
two preceding tax years.
A second method of limiting the tax is
provided for cases in which adjustments in-
crease taxable income by more than $3,000.
Under the second method, the operator must
be able to reconstruct his or her income under
the new method of accounting for one or more
consecutive years immediately preceding the
changeover year.
Continued on next page.