TAX 650 - Final Project.docx - TAX 650 u2013 Final Project...

TAX 650 – Final Project
Client: Bob
April 15, 2018
TAX 650 – Final Project

I. Memo
A. Recommended Business Entity
I recommend that Bob forms an S corporation. This will allow him to use the
accrual accounting method, share interest with his daughter, protect his personal assets,
and limit his personal liability in the company ( §1361) . S Corporations are for smaller
businesses that wish to operate as pass-through entities while also having the added
benefit of limited liability protection for the shareholders. S Corporation status gives Bob
everything he wants: ownership of the business, no double taxation, easy transfer of
ownership to his daughter, and limited liability protection ( §1366).
B. Cash vs Accrual & Revenue Recognition
The key difference between the accrual and cash accounting methods is the timing
of when revenue and expenses are recognized. The cash method recognizes revenue only
when money is actually received and recognizes expenses only when money is actually
paid. The accrual method recognizes revenue when it is earned and recognizes expenses
when they are incurred . In other words, revenue is accounted for even if no cash has been
received and expenses are accounted for even if no cash has been paid ( § 448). The most
significant impact of choosing one of these methods is the timing of revenue recognition.
The cash method forces a company to recognize revenue only when cash specifically
changes hands. On the other hand, the accrual method forces a company to recognize
revenue when it is earned, for example when a sale is agreed upon but not yet paid. The
choice of method can impact which period revenue is recognized in, meaning the it can
affect quarterly or even annual revenue levels. However, no matter which method is
chosen, the business must stick with that chosen method ( § 446).

The cash method is most common with small businesses such as sole
proprietorships or home businesses. Cash basis accounting is simple and straightforward,
providing a much more accurate picture of the amount of money that a company has. The
accrual method is the most commonly used method. This is because C/S corporations and
partnerships are required to use it and cannot elect to use the cash method, especially if
they have inventory ( § 448). The accrual method is much more appropriate for larger
businesses who must stock inventory, sell goods on credit, or enter into extended
contracts in which revenues and expenses are not immediate. The cash method does not
allow companies to have accounts receivable, whereas the accrual method does ( § 446).
If Bob is able to start his business as a sole proprietorship, the cash method may
be easier to manage with a small business. However, since Bob is considering sharing
interest in the company with his daughter – or possibly other future investors – it may be
best for him to start an S corporation. Partnerships or C/S corporations cannot use the
cash method if they have inventory. Therefore, I recommend that Bob uses the accrual