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property, or service has been paid. If the taxpayer were to receive property or services, then taxpayer must include the fair market value (FMV) in their revenue. Under the accrual basis method, the revenue recognition principle and expense recognition help the taxpayer understand that revenue is to be recorded when the service was performed, or the sale was made regardless when the receipt of cash or other property was received. As well, the expense or cost should be 3 | P a g e
Final Projectrecorded when the expense or cost was incurred, regardless of when it was paid. The matching principle is followed, matching revenue earned in a given period with those expenses or costs that were generated to earn said revenue. Accrual basis accounting is in accordance with generally accepted accounting principles (GAAP) (Kieso, Kimmel, & Weygandt, 2015.)Smaller companies that haven’t formally incorporated and most sole proprietorships use a cash method, as in most cases the cash-basis is easier for them to use on their own, meaning they don’t have to hire a large accounting staff. Incorporated companies must use accrual accounting in accordance with (GAAP) if their average annual gross receipts exceed $5 million. Secondly, if the company maintains inventory, then they must use accrual accounting. Under an accrual method, it is important to include an amount in your gross income for the tax year in which the revenue was earned. An S corporation is a flow-through entity, therefore, the business will file a tax return, however, it will not pay taxes. The income earned by the entity is allocated to the individual tax payers based on their basis in the S corporation. Therefore, in reviewing accrual method, the taxpayer will report revenue in the year that it is earned, while deducting or capitalizing expenses in the year they are incurred (IRS, 2012.) It is my opinion that your used automobile dealership should use accrual basis accounting. Revenue Recognized on the Sale: IRC Section 453 defines installment sale meaning that the disposition of property, in which at least one payment will be received after the close of the tax year. The installment method of reporting revenue is used with sales that require periodic payments over a specified time period, usually arranged by the seller by creating an installment sales contract. Installment method of revenue recognition is a conservative method. It is an idealrecognition method for large-dollar items sold, such as real estate, machinery, in which one would want to defer the gross profit. An installment sale will require specific journal entries to 4 | P a g e
Final Projectkeep accounting under a method which the income recognized and recorded for any taxable year is in proportionate of the payments received in that year which the gross profit must be realized or realized when payment is completed (Hall, 2016.) Therefore, if accrual accounting were used,the revenue would be recognized at the time of the sale, however, under cash accounting, revenue would not be recognized until cash was received.