Entrepreneurs often ask this question. Put another way, do you have to count your sales and expenses in your accounting, even they aren’t paid or received? Do you have to account for the sale, as well as the taxes, of an invoice that has been issued but not yet paid at the end of the year or the GST/QST period? The answer is yes except in a few rare cases such as agriculture, mining or fishing. This is known as accrual basis accounting, which is different from cash basis accounting.
Discover the differences and benefits when choosing between accrual or cash accounting.
What is accrual basis accounting and cash basis accounting?
Accrual basis accounting is the widely accepted accounting method in Canada. It consists of recording the accounting transactions in the registers as soon as they occur or when invoices are issued, without taking collection dates into account.
In contrast, cash basis accounting is based on cash outflows and inflows. In other words, it consists of counting the transaction in your accounting records only when the money is received or paid. Be aware, however, that this method is not really permitted and that it is used in Canada only in rare exceptions to the tax law.
Specific case of a business owner
In order to best illustrate the differences and benefits between accrual accounting and cash accounting, here is a real-life example. This should help you better understand why these questions about managing a company's accounting often come up.
Overview of the situation
A young entrepreneur has been in business for two years now in Montreal and operates his business in the legal form of a corporation. He has revenues of just under $100,000 a year and is registered for GST/QST. His tax declaration frequency is annual, and his fiscal year ends on December 31st.
Here is a list of some of his tax obligations from the end of the year:
- 2 months later: corporate taxes for Revenu Québec
- 3 months later: taxes for Revenue Canada
- 3 months later: GST/QST for Revenu Québec
The problem encountered
He billed a contract of over $30,000 at the end of the fiscal year, on December 22, and will only be paid at the end of April. However, all his tax payment deadlines are between the end of February and the end of March. This contract represents more than 40% of his revenues. The entrepreneur's liquidity is very tight and he has even had to put money into expenditure on this contract.
One of the situations he could face is owing $4,500 in fees and over $6,000 in taxes, but he does not have these amounts in the bank. Moreover, penalties for non-payment of GST/QST can be 15% plus interest. This would be a major concern for this business owner.
Next comes the question about his accounting management. What will be the most beneficial solution for him between accrual accounting and cash accounting? Specifically, is he required to include the sales of his clients that have yet to be paid at the deadline for filing their GST/QST tax report?
The accounting management solution
The regulatory response to this crucial question is ‘yes’. You must include all your amounts and must plan your cash flow to meet the deadlines for paying your tax obligations.
Some opt for cash accounting, however there are risks, especially in the case of a tax audit.
In conclusion on accrual basis or cash basis accounting
As you can see, every entrepreneur is required to use accrual accounting and must prepare for tax deadlines throughout the year. If you choose to opt for cash accounting, it is strongly recommended to consult a professional or to inquire with the authorities.
If you want the expert advice of accounting experts, do not hesitate to contact our team. We will be happy to inform you and give you the best advice possible.