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Farmers, fishers, and self-employed commission agents can use the cash method or the accrual method to report income. All other self-employment income must be reported using the accrual method.
Note for professionals
If you currently carry on a designated professional business and use billed-basis accounting, the billed-basis accounting method has changed. For more information, go to “Billed-basis accounting for professionals” in What’s new for small businesses and self-employed, and changes to the “Election to exclude your WIP” in Chapter 2 of the guide T4002, Self-employed Business, Professional, Commission, Farming, and Fishing Income.
Accrual method
When you use the accrual method you must:
- report income in the fiscal period you earn it, no matter when you receive it
- deduct expenses in the fiscal period you incur them, whether or not you pay them in that period
Incur usually means you either paid or will have to pay the expense.
For special rules, go to Prepaid expenses.
When you calculate your income using the accrual method, the value of all inventories, such as livestock, crops, feed, fertilizer, fish, fish by-products, supplies, and so on, will form part of the calculation. Make a list of your inventory and count it at the end of your fiscal period. Keep this list as part of your business records.
You can use one of the following methods to value your inventory:
- Value all inventory at its fair market value (FMV). Use either the price you would pay to replace an item or the amount you would get if you sold an item.
- Value individual items at cost or FMV, whichever is less. You can value items by group when you cannot easily tell one item from another. Cost is the price you incur for an item, plus any expenses to get it to your business location and put in a condition of use for your business.
- For farmers, value livestock according to the unit price base. For this method, fill in form T2034, Election to Establish Inventory Unit Prices for Animals.
Use the same method you used in past years to value your inventory. The value of your inventory at the start of your 2019 fiscal period is the same as the value at the end of your 2018 fiscal period. In your first year of operating a business, you will not have an opening inventory at the start of your fiscal period.
Note for farmers and fishers
If you use the accrual method to calculate your farming or fishing income, calculate your cost of goods sold on a separate piece of paper. Form T2042 or form T2121 does not have a line to calculate this amount.
Cash method
Note for farmers
You can use the cash method of accounting for your farming activities, but must use the accrual method for separate business activities or for GST/HST/QST purposes. You must keep a separate set of records for each accounting method that you use.
When you use the cash method you must:
- report income in the fiscal period you receive it
- deduct expenses in the fiscal period you pay them
For special rules, go to Prepaid expenses.
If you use the cash method and receive a post-dated cheque as security for a debt, include the amount in income when the cheque is payable.
If you receive a post-dated cheque as an absolute payment for a debt and the cheque is payable before the debt is due, include the amount in your income on one of the following dates, whichever is earlier:
- the date the debt is payable
- the date you cash or deposit the cheque
Note
The post-dated cheque rules apply to income-producing transactions, such as the sale of grain or fish. They do not apply to transactions involving capital property, such as the sale of a tractor or boat.
When you use the cash method, do not include inventory when you calculate your income. There are, however, two exceptions to this rule.
Note for farmers
For more information, go to “Line 9941 – Optional inventory adjustment included in the current year” and “Line 9942 – Mandatory inventory adjustment included in the current year” in Chapter 3 of the guide T4002.
Change your reporting method
If you decide to change your method of reporting income from the accrual method to the cash method, use the cash method when you file your next income tax return. Make sure you include a statement that shows each adjustment made to your income and expenses because of the difference in methods.
If you decide to change from the cash method to the accrual method:
- get permission from your tax services office
- ask for this change in writing before the date you have to file your income tax return
- explain why you want to change methods in your letter
The cash and accrual methods are different. The first time you file your income tax return using the accrual method, make sure you include a statement that shows each adjustment made to your income and expenses.
Forms and publications
- Income Tax Folio S4-F11-C1, Meaning of Farming and Farming Business
- Interpretation Bulletin IT-473, Inventory Valuation
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Original Source: https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/sole-proprietorships-partnerships/accounting-methods.html