- 1). Show the accounting method box on the Schedule C form to your student. To explain how to choose an accounting method to use in calculating your business profit or loss on your 1040 Form Schedule C, Box F, describe the various options first. The choices on the form include the cash method, the accrual method and a third box for the "Other" category. Concern yourself with only the first two, as this is the first and last mention of an "other" accounting method you will see on Schedule C.
- 2). Explain the cash accounting method for sales to your student. In this method, transactions are recorded when cash changes hands. Many businesses use the cash method because it is the easiest to use and to understand. A customer comes in and purchases an item, the sale is recorded and posted in your accounts at that time.
- 3). Describe to your student the accrual accounting method. In the accrual method, the sale is recorded when the agreement is reached that a transaction has take place, regardless of when payment is made. For example, a customer comes in and promises to pay for an item on credit. You agree to extend the credit and record the amount the customer owes you in your accounts receivable on the day the promise is made. If you agreed in December and are not paid until February, you must claim the income as if you had received it in December.
- 4). Contrast to the student the way the cash and accrual methods deal with expenses. With the cash method, expenses are recorded at the time they are paid, regardless of when the bill was received. Using the cash method is like keeping a check register: Income is deposited, so you post it to the register. Expenses are paid, so you post them to the register. In contrast, using the accrual method is like adding another check register that adds up all the income you would make if everyone paid you what they owed (accounts receivable) and subtracts all the expenses that would be due if you paid all the bills in your possession immediately (accounts payable).
- 5). Examine the profit-and-loss statement and the balance sheet reports. Have the student identify which accounting method is being used simply by examining the statements. If the profit-and-loss statement has accounts payable and accounts receivable sections, the company is using the accrual method. Since the cash method does not allow for extending credit to customers, no accounts receivable field is necessary. And since the cash method does not allow for accepting credit from vendors, it has no need for accounts payable. These reports are either kept in a written general journal or on an accounting software program.
- 6). Explain to your student how to plan end-of-year purchases and income accordingly based on the method you are using. For example, at the end of the year, a firm may need to order office supplies and other items. It adds those expenses to the accounts payable account and writes them off using the accrual method before it actually pays for them. If it is anticipating a large accounts receivable transaction, the agreement would be dated for the first week of the new year, so the income is not counted for the current tax year.
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