n layman's terms, accounting systems basically boil down to two types: accrual versus cash. And a company's goals help determine which method would be best. For example, if you are a sole proprietor of a small company and your goal is legal compliance with the federal tax authorities--and to take advantage of tax breaks--then you could realize significant advantages by utilizing the tax-based accounting system (the cash system) versus the accrual method.
- In order to consider something an advantage (for example, tax-based accounting systems), you need to know why another option (accrual-based accounting systems) would be a disadvantage.
If you are operating a small company--like a sole proprietorship, which means you are the sole owner--then you don't need a complicated accounting system (like the accrual-based system). In fact, it would be a disadvantage to have one and the reason why is simple: You will not have to provide extensive financial statements or asset and liability "snapshots" to a board of directors, or corporate leadership, on a monthly or daily basis. Therefore, why invest the time and money in gathering and compiling all of that information? - One advantage of the tax-based accounting system is that it is more streamlined than the accrual option. Since the system is geared to gather and process only that information pertinent to the preparation of taxes at year-end (fiscal or calendar, as the case may be), this eliminates a lot of unnecessary record-keeping that is not always needed by the company owner or managers to operate their business.
- Minimizing the amount of accounting records maintained (or prepared on a daily or monthly basis) will inevitably reduce the number of personnel needed to carry out such work. This would have a dual impact: 1) It would result in a financial advantage, since manpower needs would be reduced, as well as payroll taxes, and 2) This reduction in the accounting staff, in turn, would also reduce the number of personnel in other departments needed to supply the accounting department with this information, if it were having to be produced.
- When the focus of a company is on having a keen idea of where they sit each day in regards to federal income tax responsibility (or tax break opportunities), they are able to steer their business into another direction (and quickly) if it looks as if they need to in order to be more profitable or to avoid tax penalties.
Also, they are not so inundated with keeping and monitoring so many other financial aspects that they can't be effective in the true nature of business: paying less taxes, legitimately, and reaping more financial gain. - Implementing the tax-based accounting system also allows business owners to make better budget and acquisition forecasting predictions for their company, since they will have a better grasp of their true profit and loss margins being experienced at present--or anticipated due to tax benefits or discounts.
As purchases are made--or possible expenditures are considered--the company will focus on the tax implications of these changes prior to taking action, ensuring a more accurate "forecasting" of future profits to be realized or tax gains anticipated. These result in management having a better handle on the effects these changes will have on cash outflow and income too. - By implementing the tax-based accounting system, a company is showing a goodwill effort to be legally compliant in regards to business tax matters; therefore, it is unlikely that it will incur any unnecessary audits. But, if for some reason an error is uncovered by the Internal Revenue Service at a later date, it will be looked upon with less suspicion by tax investigators than if the accounting system used had not emphasized a focus on observing tax laws and compliance.
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