You probably think of income tax going something like this: you get a check, and some of that check is withheld for taxes. Later, you file a little form that details when you got paid and what taxes got taken out. However, if you make money from more esoteric endeavors then working for a living, things get more complicated. As such, there are other ways to calculate the amount of taxes owed.
Enter the ratable accrual method. Instead of counting income as its paid, the income gets counted as it accrues. The process often comes up related to bond income.
The calculations for the ratable accrual method can get complicated, depending on the situation, but here's a simplified example:
A bond pays you $1,200 every quarter. You are set to collect your next $1,200 check on January 31. However, your tax year closes on December 31. If you're counting the income as it's paid, the full $1,200 would count in the next tax year. However, if you calculate the income as its accrued, then $800 was accrued before the end of the year, i.e. $1,200 divided by the three months in a quarter. January's $400 counts for next year, but the $800 for November and December count for this year.
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Finance: What is Accrual Accounting?39 Views
Finance a la shmoop... what is accrual accounting? well there are two
religions in the way in which beans get counted the first is cash accounting [Cash accounting building]
which just tracks cash in the door and cash out the door in any given period [Cash enters door and exits]
the second is accrual accounting which tries to guess or impute the values
coming in and going out in a given firm hoping to give a true picture of how
well or poorly a company is performing financially and you might ask how cash
and accrual accounting can be different like aren't beans just beans that you
count well stay tuned here in accrual accounting you might have an obligation
like an employee bonus which you think is highly likely to be paid at the end [Employee happy at getting a bonus]
of the year almost treated like debt the employee makes 6 grand a month and is
very likely due 10 grand in bonus money at the end of the year it's payable on
December 31 that's when the cash would go out the door of the company but given [Cash exiting the door]
that it's highly likely to be paid or earned by the employee so they'd have a
legal claim on that 10 grand the company using accrual accounting would accrue
the liability labeled something like bonuses or or is it bony well something
like that bonus is payable.. and would accrue the
value of 10 grand divided by 12 because that's the number of months in a year in
California anyway or about 833 dollars a month throughout the year that's how you [Employee bonus divided by 12 months calculation]
would accrue for that likely bonus now promising an employee a bonus and not
giving it to them after they've earned it well that would be a cruel accounting [Person holds out cash to employee and takes it away]
a totally different thing and much more mean-spirited
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