Accrual accounting

“ That is elementary in tax law. See Security Flour Mills Co. v. Commissioner, 321 U.S. 281, 284, 64 S.Ct. 596, 597, 88 L.Ed. 725. It would seem therefore that the concept 'accrued' embodies the annual accounting principle. If, in case of a taxpayer on the accrual basis, events after the taxable year are taken into account, the word 'accrued' would be effectively read out of § 122 (d) (6) or given a varied meaning, contrary to our ruling in the Olympic Radio case. ”

“ Approved standard methods of accounting will ordinarily be regarded as clearly reflecting income. A method of accounting will not, however, be regarded as clearly reflecting income unless all items of gross income and all deductions are treated with reasonable consistency. See section 200 of the statute for definitions of 'paid,' 'paid or accrued,' and 'paid or incurred' * * * in any case in which it is necessary to use an inventory, no accounting in regard to purchases and sales will correctly reflect income except an accrual method. ”

“ The basic concept of including advances in gross income only as they are earned is but an aspect of accrual accounting principles which have consistently received judicial approval. We have, for example, often recognized that deductions for business expenses must be reported as soon as the obligation to pay becomes 'certain.' See, e.g., United States v. ”

“ The general and long-standing rule for all taxpayers, whether they use the cash or accrual method of accounting, is that costs incurred in the acquisition, production, or development of capital assets, inventory, and other property used in the trade or business may not be currently deducted, but must be deferred until the year of sale, when the accumulated costs may be set off against the proceeds of the sale. ”

“ The requirement to account for a distributive share, although the share is actually not distributed, is not a requirement to account for partnership income on an accrual basis. Since a partner's return of his partnership earnings would vary, dependent upon whether the partnership used the cash or accrual method of accounting, we do not agree with respondent's suggestion. ”

“ The United States replies that it is, and since 1914 it has been, required that a taxpayer shall keep his books and make his returns on a basis which will reflect true income; that while the taxes for any year are not payable until the following year, good accounting practice requires an accrual of them as a liability of the current year's business ”

“ In determining the amount of earnings or profits (whether of the taxable year, or accumulated prior to March 1, 1913) due consideration must be given to the facts, and, while mere bookkeeping entries increasing or decreasing surplus will not be conclusive, the amount of the earnings or profits in any case will be dependent upon the method of accounting properly employed in computing net income. ”

“ It would be disruptive of an orderly collection of the revenue to rule that the accounting must be done over again to reflect events occurring after the year for which the accounting is made, and would violate the spirit of the annual accounting system. ”

“ Yet even today it is sometimes difficult to convince the proprietor of a small business of the necessity, from the standpoint of accurate accounting, of taking cognizance of accrued and deferred expense items. Instances may sometimes, though rarely, arise in which all income has been received in cash at the end of the fiscal period and all expenses applicable to that period have been met in cash and that no deferred items need to be taken into account. Where such is the case, a statement of cash receipts and disbursements might give a fair indication of the profit and loss for the period. ”

“ Nearly every business with a well-developed accounting system can, at any time, without the formal periodic inventory or closing of its books usual at the end of a fiscal year, determine approximately the amount of its current earnings, the amount accrued since the beginning of its fiscal year, and the part thereof undistributed. ”

“ In like manner the Reserve for Doubtful Accounts is a suspense account because at the close of the fiscal period it becomes necessary to make an estimate of the probable amount of uncollectible items in order to appraise correctly the value of outstanding claims against customers. ”

“ Surplus account is frequently as badly abused as the proverbial “general” expense account, by being used as a dumping ground. It has, however, a legitimate and an illegitimate use. As the Profit and Loss account is strictly limited to use as a clearing account for the normal items of income and expense applicable to the current period’s operations, manifestly all other charges and credits to proprietorship must be cared for elsewhere. With very few exceptions—such as premiums and discounts on capital stock, donated working capital, etc.—these charges and credits are made to Surplus. ”

“ A taxpayer, having chosen to report his taxable income from installment sales on the installment cash receipts plan, thereby spreading its gross earnings and profits from such sales over a number of years and avoiding high tax rates, was not permitted to obtain a further reduction by shifting to an accrual plan and treating uncollected balances on these installment sales as though they had actually been received in the year of the sale. ”

“ These provisions plainly do not lay down any rigid rule of accounting to be applied to consolidated returns which would exclude from the computation of taxable income the results of every intercompany transaction, regardless of its effect upon the capital or the net gains or losses of the business of the affiliated corporations. ”

“ For instance, a corporation keeping its books and filing its income tax return under sections 41, 42, and 43 on the cash receipts and disbursements basis may not use the accrual basis in determining earnings and profits; a corporation computing income on the installment basis as provided in section 44 shall, with respect to the installment transactions, compute earnings and profits on such basis ”

“ Upon the complete depreciation of the asset, the book value not having been written down in the meantime because no depreciation has been booked for it, the asset must be charged against the reserve, thereby mutually extinguishing each other. No principles of accounting are necessarily violated. ”

“ The Code exacts its revenue from the individual member's dues which, no one disputes, constitute income. When their receipt as earned income is recognized ratably over two calendar years, without regard to correspondingly fixed individual expense or performance justification, but consistently with overall experience, their accounting doubtless presents a rather accurate image of the total financial structure, but fails to respect the criteria of annual tax accounting and may be rejected by the Commissioner. ”

“ Under petitioner's interpretation, the fundamental question whether an expense is properly characterized as a capital outlay which has to be amortized or instead as an ordinary business expense subject to immediate deduction would be answered by simple reference to accounting procedures in the industry. ”

“ If there is a large outstanding liability which cannot be settled, the partners will estimate that, and it will not be considered as part of the profits. If there is a large outstanding possible loss, and there is a large sum due to a client, then you would provide for that. But in ascertaining what is really actually divisible for the year fairly, you would take the cash account as it stands.” In the light of such mental obtuseness and obliquity, one cannot wonder at the occasional reluctance of business to entrust the determination of important matters to the courts. ”

“ Interest on borrowed money should not be included. The charges to operating expense on account of repairs should be adequate, and care must be taken to see that charges to the repair accounts do not show a sudden falling off toward the close of the period under review. The reserve for depreciation should be credited with the proper amounts. Sales, effected for a subsequent period, are not to be considered in the accounts of the current period as this would tend to inflate the profits. Shipments made to branch offices or on consignment account should not be regarded as sales. ”

“ It will be seen that the rule applicable to most business property of a cost basis properly adjusted leaves many problems of depreciation accounting to be answered by sound and fair tax administration. ”

“ If a careful accounting is made of the profit or loss at the time of the sale of each piece of property and these profits and losses together with the dissolution expenses are summarized and distributed to the partners’ capital accounts, those accounts will of course show the claims of the various partners on the net assets of the business after all assets have been converted into cash and all liabilities paid. ”

“ That the Court of Appeals erred in its decisionbecomes clear when the nature and purpose of the depreciation charge are analyzed and the methods of determining its proper amount are considered. The annual account of a street railway, or other business, is designed to show the profit or loss, and to acquaint those interested with the condition of the business. To be true, the account must reflect all the operating expenses incurred within the accounting period. One of these is the wearing out of plant. ”

“ Effort has been made to keep to a minimum the purely mechanical work of computation. While emphasis should be placed always on the principles involved, the need for accuracy should not be lost sight of; in its practice in business, accountancy requires accurate and, where possible, proven results.
Of the budget of stationery provided for this work, the loose-leaf supplies—statement, journal, and ledger paper—are for the first half-year’s work. The three-column paper is to be used for balance sheet and profit and loss statements, unless other directions are given for particular assignments. ”

“ For purposes of management, which must control all the phases of business activity, a balance sheet is insufficient. A review of the factors producing results up to a given time must be had. Accordingly, the accounting department must supply not only information as to the present state of the assets and liabilities, but also information which indicates how the changes in assets and liabilities since the last fiscal period were brought about—what volume of transactions occurred, what expenditures of assets and energy were necessary to accomplish the results attained. ”

“ Making a theoretical estimate of the probable, future, average, annually accruing deterioration of certain property to provide an item in bookkeeping accounts of operating expense has nothing whatever to do, in making an appraisal, with fixing the definite amount of absolute, actual, or accrued depreciation which depends upon the present condition of physical property, determinable from inspection and not upon historical documents, depreciation funds, or disputed theoretical conclusions. ”

“ It is this latter group of accounts which, as they are carried in the ledger, have both right-side and left-side balances. The income accounts, which tend to increase capital and which, when merged with the capital accounts at the beginning of the period, add to that capital, have right-side balances. The accounts which tend to decrease capital, that is, the expense accounts, because they are subtraction items, have left-side balances. [Pg 77] The net increase (or decrease) in capital for the period is the excess (or deficit) of the total income accounts over the total expense accounts. ”

“ Charge depreciation upon actual cost less any salvage.' [23]
Such is to-day, and ever has been, the practice of public accountants. [24] Their statements are prepared in accordance with principles of accounting which are well established, generally accepted and uniformly applied. By those accustomed to read the language of accounting a depreciation charge is understood as meaning the appropriate contribution for that year to the amount required to make good the cost of the plant which ultimately must be retired. ”

“ Similarly, the beginner oftentimes confuses the sales income record with the cash record of a cash sale transaction. Also, when cash is disbursed for expense purposes, the decrease in the asset is often confused with the expense record. When an expense is incurred it brings about either a decrease in assets, usually cash if the transaction is settled at once; or an increase in liabilities, usually an accrued expense item if the transaction is not immediately settled. ”

“ In so defining depreciation, tax law has long recognized the accounting concept that depreciation is a process of estimated allocation which does not take account of fluctuations in valuation through market appreciation. [2]
It is, of course, undisputed that the Commissioner may require redetermination of useful life or salvage value when it becomes apparent that either of these factors has been miscalculated. The fact of sale of an asset at an amount greater than its depreciated basis may be evidence of such a miscalculation. ”

“ Accrued Expenses represent usually the accumulating but unpaid claims against the business for service rendered it, as distinguished from the Accounts Payable, which usually represent purchases of an asset of one kind or another. Thus the amounts due at a given time to employees for work done since the last date of payment of their wages, salaries, or commissions, to the landowner for the rent of leased premises, to lenders for interest on moneys borrowed, are items properly to be listed under this title. ”