Accrual vs. the Cash Method of Accounting: Expensing Advantages
Under the Tax Cuts and Jobs Act, independent pharmacies are allowed to move from an accrual to the cash method of accounting under certain conditions. In this video, Scotty Sykes, CPA, CFP® of Sykes & Company, P.A. discusses what you need to know if you are considering this pharmacy accounting change. He shares:
• The threshold for moving to the cash accounting method.
• Advantages to the cash method of accounting.
• How Sykes & Company, P.A. can help independent pharmacies move to the cash accounting method.
If you prefer to read this content, the video transcript is below.
What is an accounting method and the options for pharmacies?
The Tax Cut and Jobs Act has completely updated how pharmacies can account on their books and records. An accounting method is, how you are recording your transactions. Under the accrual method of accounting, you’re recording revenues when you adjudicate the script, not 30 days later when you get paid from the PBM. Whereas, on the cash method of accounting, you’re actually recording the revenue when you get paid 30 days later, not when you adjudicate the script. So you can see there’s a timing difference between the two, the same goes for the expenses. You know when you’re billed, that’s an expense, not when you pay it, under the accrual method and vice versa for the cash method. So you can see again, there’s that timing difference.
And prior to the Tax Cuts and Jobs Act pharmacies had to be on the accrual method in about 99% of the cases. Pharmacies had to be under the accrual method. The Tax Cuts and Jobs Act has expanded the cash method of accounting now. So, pharmacies that are under $25 million in gross receipts can now use the cash method of accounting. And there’s a bunch of tests for that gross receipts, $25 million dollar threshold, including, actually it’s $26 million for 2019. But it’s the prior three year average gross receipts in the pharmacy, there’s a calculation on what is gross receipts, what’s included, what’s not included. And you also have to consider your controlled groups. If you own many pharmacies and you have control over those, which the rules for that are very complex. But generally speaking, if it’s a controlled group you got to combine all the pharmacies, or related business entities.
So if you pass all that, you’re under the $25 million, you can use the cash method and if you’re going from accrual method to cash method you’re typically going to see a big expense in that transition because you’ve got all these receivables booked on the balance sheet from adjudicating scripts that you haven’t been paid for yet. And if you’re going to the cash method, well that’s not income, you can adjust that out. So typically, you’ll see a big expense when you’re going from the accrual to cash method of accounting. And that big expense, you do have to be very careful with making sure you can utilize that expense, there’s limitations from a tax standpoint. So this is not something you just run out and do, it takes careful planning with your advisors, your CPA, to make sure this is the right thing for you.
What are the advantages of switching to the cash method?
Pharmacists should consider the cash accounting method as a tax planning opportunity. Given the tax reform law, the change. So it’s a perfect opportunity for tax planning and we’re talking big opportunity, you could have two, three hundred, four hundred thousand dollars of an expense which would reduce, pretty much, most pharmacies net income for the year. So huge tax planning opportunity.
Two key things you do have to be aware of, you absolutely have to make sure your books and records, your QuickBooks file or whatever it may be, that you are studying each month and taking financial statements from, that those are on the accrual method of accounting. Because a pharmacy under the cash method of accounting is going to only give you half the picture. So if you’re utilizing cash method books to analyze your pharmacy, to manage your pharmacy, you’re only getting half the picture. You have to be on the accrual basis for your books and records. But you can go back, you can do a couple accounting journal entries and go to cash at the end of the year for taxes. Very important that you still remain on the accrual method.
How Sykes & Company, P.A. can help
Sykes and Company can help in a bunch of ways here. The law’s not clear at all on this transition. Congress was not clear, the IRS has not expanded upon what the meaning in the law is, for example inventory, there’s a few different theories out there on how to handle inventory. Whether you can write that off, whether you can’t write it off under the cash method of accounting. That’s a whole other video, inventory.
But we can advise you on what the law says, what the general consensus is on how to interpret that law, as far as going, from the accrual to cash. We can also help you determine whether you need to go to the cash method of accounting, whether it makes sense from a tax mitigation standpoint, from an overall planning standpoint when we’re looking at your overall tax picture. And what you may need to do to take the most advantage of going to the cash method of accounting. Whether that’s basis injections or whatever it may be.
Again, it’s a lot of planning that goes into going from the accrual to cash, but if done right you can see some significant thousands of dollars of savings.