Generally, you can use the cash method, accrual method, or any other method permitted by the Internal Revenue Code. In all cases, the method used must clear-ly reflect income. Unless you are a qual-ifying taxpayer or a qualifying small business taxpayer (see the Part III in-structions), you must use the accrual method for sales and purchases of inven-tory items. Special rules apply to long-term contracts (see section 460 for details).
If you use the cash method, show all items of taxable income actually or con-structively received during the year (in cash, property, or services). Income is constructively received when it is credi-ted to your account or set aside for you to use. Also, show amounts actually paid during the year for deductible expenses. However, if the payment of an expendi-ture creates an asset having a useful life that extends substantially beyond the close of the year, it may not be deducti-ble or may be deductible only in part for the year of the payment. See chapter 1 of Pub. 535.
If you use the accrual method, report income when you earn it and deduct ex-penses when you incur them even if you do not pay them during the tax year. Ac-crual-basis taxpayers are put on a cash basis for deducting business expenses owed to a related cash-basis taxpayer. Other rules determine the timing of de-ductions based on economic perform-ance. See Pub. 538.
To change your accounting method, you generally must file Form 3115. You also may have to make an adjustment to prevent amounts of income or expense from being duplicated or omitted. This is called a section 481(a) adjustment.Example. You change to the cash method of accounting and choose to ac-count for inventoriable items in the same manner as materials and supplies that are not incidental. You accrued sales in 2013 for which you received payment in 2014. You must report those sales in both years as a result of changing your accounting method and must make a section 481(a) adjustment to prevent du-plication of income.
A net negative section 481(a) adjust-ment is taken into account entirely in the year of the change. A net positive sec-tion 481(a) adjustment is generally taken into account over a period of 4 years. In-clude any net positive section 481(a) ad-justments on line 6. If the net section 481(a) adjustment is negative, report it in Part V.
For details on figuring section 481(a) adjustments, see the Instructions for Form 3115, and Rev. Proc. 2006-12, 2006-3 I.R.B. 310, available atwww.irs.gov/irb/2006-03_IRB/ar14.html. Also see Rev. Proc. 2006-37, 2006-38 I.R.B. 499, available atwww.irs.gov/irb/2006-38_IRB/ar10.html.
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