Cash vs. Accrual Timing Mismatches

One issue that comes up from time to time, especially in closely held corporations, is the problem that the company may use the accrual accounting method, while the people who own the company are on the cash basis.  This can lead to timing mismatches that are costly to the business and the owners, if people are not careful.

The issue can arise because in many closely held corporations, business owners often pay corporate expenses with their personal accounts, and vice-versa.  Got an invoice for supplies?  I will put it on my personal credit card, reasoning that this is the most convenient way to handle it right now.

Accounting is not always tidy and organized, and people often think "well, I'll reconcile everything later."  The problem is that some items cannot be so easily reconciled later. 

What if the business owner takes out cash to pay for a business expense which is assumed but not invoiced until a subsequent tax year.  Let's say it is a service which is used now but not paid for after the fact. What if, and I've actually seen this happen, the invoice is delayed and does not come until the next calendar year, even for several years? 

The owner may have a serious problem.  They received cash which is theoretically tied to a corporate expense in a prior year, and then several years later the expense is actually paid.   But the business owner is on the cash basis so they can't deduct the expense when it's incurred, only when it's paid.  They may have income in the year they took money out of the corporation, and they may have a tax liability they can't offset against this income in that year.

One solution is indeed to be careful that corporate expenses are paid through the corporation, and not by owners personally.  That would solve a lot of problems. 

Another solution which isn't as good is to treat the money to the owner as a loan, well-documented of course.  However, it's possible that the tax authorities might not agree that the loan is proper, and still consider the owner to have received income.  There are a number of possible problems with running corporate expenses through personal accounts, and they can't always be solved by clever accounting.  So the lesson is to avoid this trap whenever possible, and keep corporate and personal accounts segregated.


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