“Accounting Methods recognized by the Tax Code”

The taxable income of a taxpayer shall be computed in accordance with the method of accounting he regularly employs in keeping his books. However, if the taxpayer does not regularly employ a method of accounting which reasonably shows his correct income, the computation of income shall be made in such manner as in the opinion of the Commissioner of Internal Revenue or his -duly authorized representative
that clearly reflects such income.

Here’s the method that can be used:

A. Cash Basis is a method of accounting whereby all items of gross income received during the year shall be accounted for such taxable year and that only expenses actually paid for shall be claimed as deductions during the year. This method of accounting is generally used by taxpayers who do not keep regular books of accounts.

Under this method, income is realized upon receipt of cash or its equivalent including those constructively received (such as deposits for the taxpayer’s account by customers) but not including gifts or donations. Users of cash basis accounting are mostly individuals engaged in business and practice of profession, professional partnerships and professional service organizations.

 

B. Accrual Basis is a method of accounting for income in the period it is earned regardless of whether it has been received or not. In the same manner, expenses are accounted for in the period they are incurred and not in the period they are paid.

Under this method, net income is being measured by the excess of income earned during the period over the expenses incurred. Expenses not being claimed as deductions by taxpayers in the current year when they are incurred cannot be claimed as deduction from
income for the succeeding year.

Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year. The accrual basis of accounting is being used by
taxpayers whose nature of business uses inventories since this method of accounting will correctly reflect income by matching purchases and expenses against sales.

This method is being applied by most medium and large corporations.

 

C. Completion of Contract Basis is an accounting method applicable to contractors in the construction of building, installation of equipment and other fixed assets, or other construction work covering a period in excess of one year.

Under this method, gross income is to be reported in the taxable year in which the contract is fully completed and accepted by the contractee if the taxpayer elected it as a consistent practice to treat such income, provided that such method clearly reflects the net income.

Under this method, all expenditures, are deducted from gross income during the life of the contract which are properly allocated thereto, taking into consideration any materials and supplies charged to the work under the contract but remaining on hand at the time of the completion.

However, pursuant to Republic Act No. 8424 which took effect on January 1, 1998, contractors are no longer allowed to adopt this method of reporting their income derived in whole or in part from long-term contracts.

D. Percentage of Completion Basis is a method applicable in the case of a building, installation or construction contract covering a period in excess of one year whereby gross income derived from such contract may be reported upon the basis of percentage of completion. In determining the percentage of completion of a contract, generally one of the following methods is used:

1. The costs incurred under the contract as of the end of the tax year are compared with the estimated total contract costs; or
2. The work performed on the contract as of the end of the tax year is compared with the estimated work to be performed.

In such case, the return should be accompanied by a certificate of the architect or engineer showing the percentage of completion during the taxable year of the entire work performed under contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the materials and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied.

Beginning January 1, 1998 income from log-term contracts are required to be reported using this method only.

E. Installment Basis is a method considered appropriate when collections extend over relatively long periods of time and there is a strong possibility that full collection will not be made. As customers make installment payments, the seller recognizes the gross profit on sale in proportion to the cash collected.

 

F. Crop Year Basis is a method applicable only to farmers engaged in the production of crops which take more than a year from the time of planting to the process of gathering and disposal. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops are realized.

#referenceRAMO12000

 

 

 

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