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The Basics Underlying The Accrual Basis Of Accounting

While calculating the taxable income of the organization or an individual there are, in general, two methods that are the cash based method, and the accrual based method. In many cases a different method can be used if the chapter permits it and in many cases the change of method from cash to accrual or vice versa can also be done but only after obtaining the permission of the secretary. In the cash based method income is included when the payment is received and deductions are claimed when the expenses are paid. The accrual based accounting method is a bit different than this method.

In the accrual based accounting method the items are included when they are earned and the deductions are claimed when the expenses are incurred. Under the all events test the tax payer must include the income when all the events have occurred that ensures that the income is due in the financial year and the income can be estimated. According to the earlier test, the tax payer includes the income when a) the requisite performance has occurred and the payment is due b) payment therefore is made or whichever happens earlier.

In accordance with the earlier of test the tax payer can sometimes also be considered as the cash based tax payer when the payment is received before the required performance and well before it is due. The accrual based tax payer can actually claim deduction when the events have taken place that establishes the fact that the liability is due. The amount of the liability can also be calculated with some reasonable accuracy.

In the initial days, only the cash based tax system was prevalent all across the globe. However the businesses that were operating upon the accrual based accounting system started objecting as they were operating in accordance with the generally accepted accounting principle (GAAP). It was formulated into the system in the year 1916 in the US tax law. Many of the other countries have also now adopted this system of tax paying as one of the basis of the accounting.