An accounting method is a set of rules used to determine when and how income and expenses are reported. Taxable income should be determined using the method of accounting regularly used in keeping the corporation's books and records. In all cases, the method used must clearly show taxable income.
Generally, permissible methods include:
- Accrual, or
- Any other method authorized by the Internal Revenue Code.
Generally, a corporation (other than a qualified personal service corporation) must use the accrual method of accounting if its average annual gross receipts exceed $5 million. A corporation engaged in farming operations also must use the accrual method.
If inventories are required, the accrual method generally must be used for sales and purchases of merchandise. However, qualifying taxpayers and eligible businesses of qualifying small business taxpayers are excepted from using the accrual method for eligible trades or businesses and may account for inventoriable items as materials and supplies that are not incidental.
Under the accrual method, an amount is includable in income when:
- All the events have occurred that fix the right to receive the income, which is the earliest of the date:
- The required performance takes place,
- Payment is due, or
- Payment is received and
- The amount can be determined with reasonable accuracy.
Generally, an accrual basis taxpayer can deduct accrued expenses in the tax year when:
- All events that determine the liability have occurred,
- The amount of the liability can be figured with reasonable accuracy, and
- Economic performance takes place with respect to the expense.
There are exceptions to the economic performance rule for certain items, including recurring expenses. See section 461(h) of the Internal Revenue Code and the related regulations for the rules for determining when economic performance takes place.taxmap/pubs/p542-004.htm#TXMP123550a1
Accrual method corporations are not required to maintain accruals for certain amounts from the performance of services that, on the basis of their experience, will not be collected, if:
- The services are in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; or
- The corporation's average annual gross receipts for the 3 prior tax years does not exceed $5 million.
This provision does not apply if interest is required to be paid on the amount or if there is any penalty for failure to pay the amount timely.taxmap/pubs/p542-004.htm#TXMP6721139c
Long-term contracts (except for certain real property construction contracts) must generally be accounted for using the percentage of completion method described in section 460 of the Internal Revenue Code.taxmap/pubs/p542-004.htm#TXMP07a535c9
Generally, dealers in securities must use the mark-to-market accounting method described in section 475 of the Internal Revenue Code. Under this method any security held by a dealer as inventory must be included in inventory at its FMV. Any security not held as inventory at the close of the tax year is treated as sold at its FMV on the last business day of the tax year. Any gain or loss must be taken into account in determining gross income. The gain or loss taken into account is treated as ordinary gain or loss.
Dealers in commodities and traders in securities and commodities can elect to use the mark-to-market accounting method.taxmap/pubs/p542-004.htm#TXMP354aa66f
A corporation can change its method of accounting used to report taxable income (for income as a whole or for the treatment of any material item). The corporation must file Form 3115, Application for Change in Accounting Method. For more information, see Form 3115 and Publication 538.taxmap/pubs/p542-004.htm#TXMP216b685a
The corporation may have to make an adjustment under section 481(a) of the Internal Revenue Code to prevent amounts of income or expense from being duplicated or omitted. The section 481(a) adjustment period is generally 1 year for a net negative adjustment and 4 years for a net positive adjustment. However, a corporation can elect to use a 1-year adjustment period if the net section 481(a) adjustment for the change is less than $25,000. The corporation must complete the appropriate lines of Form 3115 to make the election.