Under the accrual method, which is much more common in most businesses, transactions are counted when they occur, regardless of when the money is actually received or paid out. In the case of an optometric practice, this means that as soon as an examination is completed it becomes revenue. (Unrealized revenue - money owed to the practice that doesn't come in - is deducted as an expense. In this way, total revenue over time is identical with either method.) Expenses are counted when they "used" rather than when they are paid. For example, insurance is often paid once a year, but it's "used" every month. With accrual basis accounting, an expense is recorded every month for one-twelfth of the annual premium.

Accrual basis accounting better represents how the practice obtains and uses its resources, making it easier to spot oncoming problems and make more accurate comparisons with other months, for management planning purposes.

Tax Impact

Under both the accrual and the cash methods of accounting, business owners can deduct the cost of goods sold from income as an expense. However, under the cash method, business owners may deduct only the cost of purchases that they have actually paid during that year. Inventory item purchases are the one exception to the above rule. "For inventory items, optometrists who wish to implement cash basis accounting must capitalize the cost of these items at the end of their tax years. That means, under the cash basis method of accounting, you may record as an expense only the cost of inventory items actually dispensed to patients before the end of your tax year. You can no longer directly expense inventories when purchased," Sills said.

It is often said that the cash method has the tax advantage of not paying income tax on revenue that hasn't been received. While technically true, the actual impact is zero except for the very first month after switching from cash basis to accrual basis.

The new IRS-approved procedures (allowing practices to use cash basis accounting for tax purposes) apply only to practices with less than $10 million in gross annual revenue, based on an average of the last three years' revenue.

Time for change?

Ultimately the accrual and cash methods provide the same information about a practice. With accrual basis accounting, practitioners can tell more quickly if business in the dispensary is down or up, for example, and can recognize variances in expenses much more easily and quickly. They can therefore take action to help increase revenues or control expenses in a more timely fashion. Accrual accounting can also help practitioners head off potential cash shortages in advance. But cash basis accounting is what most of practices use now, and there are additional bookkeeping and accounting expenses associated with switching. In the end, practitioners must determine which accounting method is best suited for their practices.

Lastly, if a practitioner feels a change in accounting systems is in order, that change should be made now, as a new tax year approaches. Practitioners who decide to change their accounting methods, in the vast majority of cases, must get permission from the IRS. To make a change, practitioners usually must file IRS form 3115, Application for Change in Accounting Methods; business owners should consult with a tax advisor to determine if such permission is required for their practice.