I have a question about managing invoice generation and cheque-cashing (withdrawal) events in a cash basis system. Here’s my issue:
In April 2016, I issued a cheque for services rendered to a supplier. I track services rendered using purchase invoices. The supplier didn’t actually cash the check until January 2017.
So, in a cash basis system, my books need to recognize that the accounting event was triggered in April 2016 (so 1099s and W-2s can stay in sync for 2016).
However, my issue is that my bank account shows a withdrawal for that purchase invoice (the cheque getting cashed) in January 2017.
My question is this:
How do I show that the supplier’s cheque was issued (and in a cash basis system, effectively paid) in April 2016, when I see two separate transactions listed in my ledger?
I imagine that there’s a pretty common technique or best practices that I should be following in Manager.io, as this seems to be a pretty typical situation.
No, in a cash basis system your books don’t recognise the accounting event until the cash event occurs (Jan 2017), otherwise to have it recognised as triggered in April 2016 it would be on an accrual basis.
Thanks for the quick response. However, your comment appears to go against the Doctrine of Constructive Receipt, which suggests that, in my scenario:
When the supplier has receipt of the cheque, the accounting transaction is complete, regardless of when the supplier actually cashes (realizes) the cheque.
This seems to be the definition of constructive receipt, and hence, goes directly to my issue.
Yes the transaction is complete, in that the supplier has received payment, they can no longer demand payment. However, cash accounting is about the actual cash events, not about the actions taken (giving a cheque) to make that event.
@richbl, you are missing nothing, and the principle of constructive receipt is exactly what applies. The IRS defines when to recognize income and expenses under cash basis accounting using that principle. See Publication 334. Like many things, the IRS defines one thing by defining another. The rules explicitly invoke constructive receipt for when income should be recognized. They are slightly less precise when defining expenses, saying in Pub 334, “Under the cash method, you generally deduct expenses in the tax year in which you actually pay them.” But since expenses are the reverse of income, the constructive receipt principle applies. And you have paid when you have written the check. Pub 334 includes another specific statement applying to checks: “Receipt of a valid check by the end of the tax year is constructive receipt of income in that year, even if you cannot cash or deposit the check until the following year.” The simple way to think of this situation is to realize that, once you write the check, you no longer have the corresponding cash asset available for any other purpose. The recipient could deposit the check at any moment.
The way you handle this with your accounting records and various tax filings is to report the expense on the date you wrote the check in April 2016. Mark the transaction as Pending on Manager’s payment transaction form. Include a bank reconciliation statement as of December 31, 2016. The reconciliation statement will clearly include the amount of the check with pending withdrawals. No auditor or IRS agent will be confused.
So the cash basis accounts plus the bank reconciliation = the tax filings for your jurisdiction.
In most parts of the world however the cash basis accounts equals the tax filings.
The same is true in the USA. You just need to look at Actual balance instead of Statement balance. Depending on bank procedures, the statement balance could be 30 days behind. You would not think of leaving bank transactions out of your accounting just because you had not yet received a statement from the bank including them.