Farms, unlike many other businesses in Canada, can still use the cash method of accounting. Even so, many farms find the accrual accounting system a more useful business tool.
The main difference between these accounting systems is the point in time at which you account for each income or expense item.
In cash accounting you record a sale or expense only when the cash is received or paid. Inventory is not included in the calculation of income.
With accrual accounting you record income and expenses when a sale or purchase is made, even if the money hasn't yet changed hands.
There are a number of key advantages to using accrual accounting:
Make Better Business Decisions
Accrual accounting provides you detailed up-to-date financial information not possible with the cash accounting method. This information lets you know how your operation is doing at a specific point in time—essential in making sound business decisions.
Specifically, accrual accounting lets you produce financial statements:
A balance sheet lists business assets and liabilities as of a specific date, along with owner equity. This statement is useful in assessing a business's risk position, solvency, ability to meet current debts, and changes in equity.
Statement of Retained Earnings
The statement of retained earnings (capital) summarizes changes in earnings retained in the business during the period under review.
The income statement summarizes business income and expenses and provides a measure of profitability for the period under review.
Statement of Cash flow
The statement of cash flow helps in assessing business solvency and liquidity, as well as the ability to generate cash from internal sources, repay debt obligations, reinvest, and make distributions to owners.
Get More Money from the Bank
Today, banks and lending institutions expect more detailed financial information before they grant credit under tightened loan criteria policies adopted over the past several years.
With accrual accounting you'll be able to provide this detailed financial information and, therefore, gain greater access to borrowed capital.
Additionally, historical financial reports are key components of a business plan and give your financial projections more credibility in the eyes of the bank.
Access Government Support Programs
Government support programs like AgriStability require a form of modified accrual information. Even if you file your income tax return using the cash method, your AgriStability program year margin will be adjusted for changes in inventory, accounts payable and receivable, and purchased inputs.
Help Your Tax Specialist Help You
Good accrual-based financial records help your tax specialist access all tax credits, tax deductions, and income deferrals available to you when completing your tax returns.
Survive a CRA audit
If you're ever audited by Canada Revenue Agency (CRA), accrual accounting arms you with the detailed financial records to support your compliance filings.
Be sure to check out some tips for avoiding a CRA audit.