Daily Archives: March 18, 2025

What is Accrual Accounting? 

Accrual accounting is an accounting method that allows a company to record revenue anytime a payment is received. This method provides a clearer picture of the company’s finances by identifying transactions as and when they occur.  

It is the standard accounting method that is typically recommended by the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). It ensures compliance with regulatory bodies.    

Qualifying for Accrual Accounting  

All businesses, including companies that have an inventory or make sales on credit (except those that identify as small businesses), with an average annual gross receipt of $25 million+ in the past three years need to use the accrual basis of accounting method.   

How Does Accrual Accounting Work?  

Accrual basis of accounting is based on the matching principle. According to this principle, income and costs must be documented during the same accounting period that they are earned or incurred. This ensures that the financial statements of a company are clear and offer an accurate picture of its profitability.   

Benefits of Accrual Accounting  

Accurate view of company performance

By recording earned or incurred revenues and expenses as they happen, accrual basis of accounting provides a clear picture of a business’s profitability.  

Revenue tracking

Even if the payment is received much later, a business can use accrual basis of accounting to record transactions as they happen, which makes it easier to track revenue and cash flow.  

Financial Planning

Accrual basis of accounting makes financial planning, forecasting, and budgeting easier by recording income and expenses as they occur.  

Improved Performance

Accrual accounting gives businesses a better grasp of their financial performance, which gives them a clearer understanding of their financial performance. This, in turn, leads to better decision-making.  

Better Tax Planning

Keeping an accurate financial record lowers the possibility of mistakes being made while filing taxes and enhances compliance with tax laws.  

Streamlines Audit Workflows

Accrual basis of accounting makes internal and external audits easier since it maintains accurate and well-documented financial record. 

What is an Accounting Period? 

An accounting period is a specific time frame used by businesses to record financial transactions and prepare financial statements. It usually consists of weeks, months, quarters, calendar years, or fiscal years. Accounting periods are essential for tracking financial performance and ensuring accurate financial reporting. 

Why is an Accounting Period Important? 

An accounting period provides a structured way to measure a business’s financial performance and helps ensure compliance with financial regulations. It plays a critical role in decision-making for business owners, investors, creditors, and regulatory agencies who rely on accurate financial data. 

Performance Evaluation

Helps businesses assess their profitability and financial health by tracking revenues, expenses, and overall financial trends. Regular assessments allow companies to identify growth opportunities and financial risks. 

Comparability

Ensures financial results can be compared across different periods. This helps stakeholders analyze trends, measure performance, and benchmark against industry standards. 

Regulatory Compliance

Businesses must report financial results within specific accounting periods to comply with IRS regulations, SEC requirements, and other financial reporting standards. 

Decision-Making

Accurate accounting periods provides reliable financial data for business planning, budgeting, investments, expansion, and cost management.  

 

Types of Accounting Period 

Most businesses use a 12-month (1-year) accounting period, but the start and end dates can vary based on business needs and tax regulations. The IRS allows taxpayers to choose between a calendar year or a fiscal year for tax reporting. 

1.Calendar Year 

A calendar year accounting period follows the standard January 1 – December 31 timeline. Many businesses and individuals use this period for financial reporting and tax filing as it aligns with standard tax deadlines. 

 

2. Fiscal Year 

A fiscal year is a 12-month accounting period that can start on any date instead of following the calendar year. Businesses set their fiscal year based on their operational needs and industry trends.

What is Asset Depreciation? 

Depreciation is an accounting procedure that helps businesses allocate or calculate the cost of a tangible asset over its estimated useful life. 

For example, if a business purchases a machine for $10,000 and expects it to last for 10 years, the machine’s value will gradually decrease each year. The business will “depreciate” a portion of the machine’s value each year to reflect this decline. 

Asset depreciation specifically refers to the depreciation of a particular asset, like machinery, buildings, or equipment, over time. The primary purpose of asset depreciation is to match the cost of an asset with the revenue it generates over time. It is crucial for businesses because it impacts tax calculations and provides a more accurate reflection of asset values on financial statements. 

What is an asset? 

An asset is anything of value that is expected to provide economic benefits in the future. It can be either tangible (physical items like a delivery truck) or intangible (non-physical items like a patent).  

How does Asset Depreciation work? 

When an asset is used, its value decreases over time due to wear and tear or becoming outdated. This decrease in value is usually reflected in financial statements and is used by businesses to allocate costs over the asset’s useful life. 

To calculate depreciation accurately, here are the key elements to consider: 

Depreciation Start Date

The calculation begins when the asset is first used in business operations. 

Estimated Useful Life

An estimate of how long the asset will remain productive for the business. 

Initial Cost

The amount paid to acquire the asset, including taxes, installation costs, and any other fees necessary to bring the asset into working condition. 

Residual or Salvage Value

The estimated value of the asset at the end of its useful life when it is either sold, repurposed, or reconditioned. 

Types of Depreciation 

In the US, it is mandatory for accountants to calculate depreciation as per the rules set by GAAP (Generally Accepted Accounting Principles). 

Straight-Line Depreciation 

The most common method, the straight-line depreciation, spreads the cost of the fixed asset evenly over its useful life. 

Straight-line depreciation Expense   =	Cost of Asset – Salvage Value
	Useful Life of an Asset

 

Double-Declining Balance Depreciation 

The double-declining balance method depreciates the asset more quickly in the earlier years of its useful life.  

Double Declining Balance =	2 x	Cost of Asset  –  Accumulated Depreciation
		Useful Life of an Asset

 

Units of Production Depreciation 

This method bases depreciation on the asset’s usage, activity, or units produced per year. It is mainly used in the manufacturing sector. 

Depreciation Expense =	(Original Value – Salvage Value)	X Units Produced
	Estimated Production Capacity

 

Sum-of-the-Year’s Digits Depreciation 

The sum-of-the-year’s digit depreciation method calculates the percentage based on the sum of the number of years in an asset’s useful life. 

Depreciation Expense =	Remaining Useful Life	X Depreciable Cost
	Sum of the years’ digits

 

What is Alternative Minimum Tax? 

The Alternative Minimum Tax (AMT) is the minimum amount of tax the IRS levies on taxpayers with high income in addition to the regular income tax.  It is a parallel tax system designed to ensure that taxpayers with high-income pay at least a minimum amount of taxes. 

Purpose of Alternative Minimum Tax (AMT) 

AMT helps to ensure that high-income taxpayers contribute their fair share to the federal tax system. It helps prevent taxpayers who might otherwise use deductions and loopholes from paying little to no income tax.   

Over the years, AMT exemption limits have increased due to inflation adjustments. The Tax Cuts and Jobs Act (TCJA) of 2017 raised exemption limits, limiting the number of taxpayers who are subject to the AMT. Additionally, credits have been introduced to help reduce the overall tax amounts. 

How is Alternative Minimum Tax Calculated? 

A taxpayer has to pay AMT only if the tentative minimum tax for the year is greater than the regular taxable income for that year. In simple terms, if the AMT calculation results in a higher tax than the regular tax, the taxpayer must pay AMT. 

The calculation of the Alternative Minimum Tax (AMT) involves several steps, typically determined using IRS Form 6251.  

• Calculate your regular taxable income as per standard tax rules 

• Add back specific AMT tax preference items, such as investment tax credits, capital gains, state and local taxes, interest earned from bonds, and other applicable items.  

• Subtract the predetermined AMT exemption amount. 

• Apply the AMT tax rates to the resulting amount 

• Compare the AMT liability with your regular tax liability. If the AMT liability is higher, you will need to pay the AMT amount.  

Alternative Minimum Tax Exemption Amounts 

The AMT exemption limit is designed to exclude the lower income and middle class from being penalized. 

For 2025, the exemption amount for unmarried individuals has increased to $88,100 ($68,650 for married individuals filing separately) and phases out at $626,350. For married couples filing jointly, the exemption amount increased to $137,000 and phases out at $1,252,700.