By Cliff Ennico
“Last year I started a business selling on eBay. I’m doing my taxes now and my accountant is telling me I have to choose between the ‘cash’ and ‘accrual’ methods of accounting. Frankly, I haven’t been doing any accounting as such. When people pay me, I just deposit their checks or money orders into my business checking account (I’m not using PayPal yet, though I plan to next year). Could you please explain the difference between these two accounting methods in language I can understand?”
As Curly Joe Howard of “The Three Stooges” used to say, “soitenly.”
The IRS allows small businesses to use two different accounting methods — the cash method and the accrual method.
Under the cash method of accounting, you report sales when, and only when, you actually receive the cash from your buyer or winning bidder. So, if someone buys something from you on eBay and pays with a check or money order, you do not report the sale until the check or money order has arrived. It doesn’t matter whether you hold on to the check for a few days before depositing it into your account (as many folks do, especially in late December when they’re trying to push income into the next tax year); you record the sale when the buyer’s check hits your mailbox.
EXAMPLE: Joe sells laptops on eBay. Joe puts a laptop up for sale on eBay using a seven-day traditional auction format that closes on Sunday night. At the end of the auction, Mary is the winning bidder at $500. Mary elects to pay by personal check and mails the money order to Joe on Monday morning. Joe receives Mary’s check on Thursday and deposits it in his business checking account on Friday. The check clears the same day. Using the cash method of accounting, Joe records the $500 sale on Thursday, when he received the check.
Under the accrual method of accounting, you report sales when you have the legal right to payment, even if you haven’t received the cash. So, if someone buys something from you on eBay and pays with a check or money order, you can report the sale as having occurred the moment the auction ended, even though it will be a few days before you receive the buyer’s check or money order.
EXAMPLE: Mary sells Barbie Dolls on eBay. On Monday, Mary puts a genuine 1971 Malibu Barbie (the one with the sunglasses sewn to her head) up for sale on eBay for a fixed price of $1,000 using eBay’s “Buy It Now” feature. On Wednesday, Alphonse clicks the Buy It Now button and buys the Malibu Barbie doll for $1,000. He chooses to pay for the doll by personal check and mails the check to Mary on Thursday morning. Mary receives the check on Monday and waits until Tuesday to deposit the check to her business checking account, which means the check doesn’t clear the bank until the following Friday. Because Mary uses the accrual method, Mary must record the $1,000 sale on Wednesday — the day Alphonse bought the doll on eBay and became legally obligated to purchase the doll — even though she doesn’t actually receive good funds until the following Friday, when his personal check clears her bank.
Under either the cash or accrual method of accounting, holding on to a check or money order for several days before depositing it does not affect the recording of the sale. You record the sale either when the check or money order arrives in your mailbox (cash method), or when the eBay auction closes and the winning bidder has been identified (accrual method). If you have a PayPal account and use the cash method, you record a sale when the buyer’s payment hits your account.
Still not sure what to do? When in doubt, select the accrual method. Just about all eBay-selling businesses have inventory, and the accrual method gives a more accurate picture of sales and income for a business that has inventory. Besides, when you find yourself selling more than $1 million worth of stuff on eBay each year (you should be so lucky, right?), the IRS will require you to use the accrual method anyway, so you might as well get familiar with it now.
Hey, you never know.
Cliff Ennico (email@example.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt.”
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