Accounting Methods — General Principles (Portfolio 570)

Description

Tax Management Portfolio, Accounting Methods — General Principles, No. 570 T.M., discusses the tax effects of selecting an accounting method. In general, any consistent and predictable treatment of a material item of income or expense constitutes an accounting method. The two most commonly used methods of accounting are the cash method and the accrual method, but any method of accounting that clearly reflects income generally will be permitted. The determination as to what clearly reflects income, however, depends on tax accounting principles, which frequently deviate from generally accepted accounting principles. If the two conflict, tax accounting principles control for tax purposes.

Taxpayers must compute their taxable income using the same accounting method used in keeping their books. They are not required, however, to use the same method for preparing financial statements. Taxpayers also may be required to change their method of accounting to a method that clearly reflects income. If a taxpayer initiates a change in method of accounting, including a change from a method that does not clearly reflect income, it must receive permission from the Internal Revenue Service.

Issues discussed in this Portfolio include: (1) the definition of an accounting method; (2) the significance of differentiating between a “permissible” and an “erroneous” accounting method; (3) the problems of conforming tax accounting with accounting for financial statements and other reports; (4) the “all events” test used to determine when an item of income or expense is taken into consideration under the accrual method of accounting; (5) limitations on the use of the cash method of accounting; and (6) the economic performance requirement under the accrual method of accounting. It also outlines the consequences of using an accounting method that does not clearly reflect income.

For a discussion of the rules governing how to adopt or change an accounting method, see 572 T.M., Accounting Methods — Adoption and Changes.

This Portfolio may be cited as White, 570 T.M., Accounting Methods — General Principles.

Table of Contents

I. Introduction and Statutory Outline
II. What Is a Method of Accounting?
III. Permissible Methods of Accounting
IV. Inclusions in Income
V. Deductions and Credits