i. The difference between the cash basis and accrual method of accounting is dependent upon the sales and purchase that is recorded the accounting books. Under the cash method of accounting the revenues and the expenditure are identified based on the situations when there is a change of hands (Bushman et al., 2016). While in accrual accounting method the revenues are identified as and when it is earned. A taxpayer may use either cash or accrual method of accounting depending upon the definite factors. The cash method is easy to understand and maintain.
Under the cash method of accounting there is accrual allocation or computations. As held in “Carden v FC of T (1938)” majority of the business functions is completely carried out based on the cash method as business might sell the products for which payments are received later or any other types of transactions that arises and payment which is received in later instances (Nallareddy et al., 2017). The court in “Henderson v FC of T (1970)” held that under the accrual method of accounting a business is provided with the better situations regarding the expenses and income that arises from the profitability. Factors namely the double entry bookkeeping might be held as the valuable in deciding regarding the method of business to understand the information relating to the bookkeeping equation. Factors such as cash flow is regarded as the best element in understanding the method of accounting that provides the business with the better scenario of the cash flow.
Certain factors affecting the choice of accrual or cash basis of accounting is given below
a. Business size
b. Complexity of business
c. Amount of business income obtained by taxpayer direct effort.
d. Debt receivable
Frank can adopt either the cash method or accrual method of accounting. Citing the reference of “Henderson v FCT (1970)” Frank can opt for accrual method of accounting as this would provide assistance in recognizing the revenues depending upon the receipt of revenues and expenses that is obtained (Ball et al., 2016). This method will be considered useful in recognizing the accounts receivable or the accounts payable. Frank should undertake the decision of choosing the accrual basis of accounting because it is easy to maintain.
Additionally, it is simple to identify whether the accounting transaction has been occurred with no such requirement of keeping track of the receivables or the accounts payables (Barkoczy, 2014). In case of Frank, he has the choice of undertaking the cash or the accrual method of accounting. Accrual method of accounting is regarded as the accounting for GST based on the business activity statement that would take into the consideration the period in which the business makes the purchase and sale.
The taxation commissioner can insist on adopting a specific method of accounting. The commissioner of taxation explains that an individual taxpayer is considered for taxation purpose relating to the income that is obtained based on the business receipts received by the taxpayer irrespective of when the work was carried out (Coleman & Sadiq, 2013). The taxation commissioner insist that the business is required to take into the account the payments which is eventually received for the year is assessable income. According to the taxation commissioner a business that have the aggregate turnover of less than $10 million can chose to account under cash method for GST purpose.
The court in “FC of T v Firstenberg (1976)” held that accounting for cash basis constitute that the business must account for the GST in the business activity statement. It should cover the accounting period where the business obtains or pays for purchase and sale (Grange et al., 2014). The taxation commissioner insist that a business obtains the advantage under the cash method since this method is useful for a business in supporting the alignment of liabilities of business activity statement with easy management of cash flow.
iv. The present case situation of Frank highlights that during the accounting year of 2016/17 Frank derived the revenue of $75,000 however in the following year of 2017/18 the yearly sales turnover of the company amounted to $2.5 million. During the financial year of both 2016/17 and 2017/18 the company’s annual turnover stood below the agreed limit of $10 million. The court of law in “FC of T v Dunn (1989)” held that a business under the cash basis of accounting is required to record transactions based on the cash basis given the business exceeds prescribed annual turnover limit of lower than $2 and $10 million correspondingly (James, 2014).
As understood in the current situation of Frank the accounting method would remain the same for the accounting year of 2016/17 or 2017/18 as Franks business is primarily small and less than the yearly turnover boundary of $10 million. Frank is required to account for the input tax credit for creditable purpose but up to the extent that the company offers considerations for the taxation period (Jover-Ledesma, 2014). The accounting method for Frank for the year 2017 and 2018 would remain same as Frank is required to account under the cash basis.
v. The availability of the software package makes the traditional accounting method or the accrual accounting method irrelevant. Using the electronic method accounting helps in creating a difference between the traditional accounting method (Bushman et al., 2016). The cash basis of accounting is usually preferable for the business that reports an annual turnover of lower than $2 million.
The introduction of electronic software has resulted in different treatment of accounting records. The cash and accrual accounting method is different from the traditional accounting method (Nallareddy et al., 2017). For instance, under the electronic method of accounting maintaining the business record is easy because the electronic software enables a business in keeping record of the expenses and income particularly the purchase of assets, stock valuation at the end of accounting year together with the employee payment. Hence, the accounting software packages are easy to keep record of business cash flow and render a true view of business cash and bank balances.
a. The two positive limbs of “section 8-1 of the ITAA 1997” explain that a person can deduct from their taxable income any expenditure or the losses up to the extent that the expenses is occurred for obtaining the taxable income or it occurred in performing the business with the objective of producing their taxable income (Ball et al., 2016). The Australian Taxation Office explains that a person can claim deductions for certain expenditure a taxpayer incurs when the property is rented out. As defined under “subsection 25-10 (1)” the term repair comprises of restoration of asset to the previous state without changing the essential character or functions.
The court of law in “BP Oil Refinery Ltd v FC of T (1992)” held that the repair consists of the renewal and replacement of the subsidiary part of a whole but does not comprise of overall reconstruction. Ruby incurred cost on replacing the fittings of kitchen and deteriorated cupboard which was destroyed in storm. With reference to “section 8-1 of the ITAA 1997” Ruby would be allowed to claim a general deduction for the repairs expenses (Barth et al., 2016). The costs of repairs represent restoration of the asset functions and efficiency with no changes or improvement in character of the asset.
b. Certain legal spending incurred in generating the rental income are considered for deductions. This includes the expenses incurred in evicting the non-paying tenant, taking the actions of court due to loss of rental income and taking defending the claims for damages relating to injuries that is suffered by the third party on their rental property (Gordon et al., 2017). As held in “Herald & Weekly Times v FCT (1991)” the court allowed the taxpayer with deductions for the costs that are incurred as the consequence of taxpayer income producing activities.
During the year Ruby incurred legal expenses of $7,000 since one of her tenants skidded on the steps and sustained injuries. Therefore, legal expenditure $7,000 will be allowed for deductions because the expenditure is incurred in defending the claims of the injuries which is suffered by the tenant on rental property. The expenditure would be entitled to deduction because since it arises from the letting of the property to the tenant with the objective of claiming taxable income and can be appropriately held as having occurred in the course of gaining or generating the taxable income (Kenny, 2013). The legal expenditure possesses appropriate connection with the rental income with the expenses are becoming incidental and relevant in the generation of the taxable rental income.
c. As defined under the to “section 8-1 of the ITAA 1997” an individual taxpayer is allowed to claim deductions from their assessable income relating to the expenses that is incurred in gaining the assessable income (Krever, 2013). However, a taxpayer is denied deductions for the expenses that are domestic, private or capital in nature or associated in the derivation of the exempted income. The taxation commissioner in “Hallstroms Pty Ltd v FCT (1946)” held that in determining whether the deductions for the legal expenditure is allowed under the provision of section “section 8-1 of the ITAA 1997”, the character of the expenses must be considered (Morgan et al., 2013). As understood in the present situation of Ruby Pty Ltd because the company has occurred expenditure on paying the compensation damage. The claim settlement amount stood $750,000 for the car manufacturing company.
Citing the reference of the court decision in “Sun Newspaper Ltd v FCT (1938)” it was held that the expenses that is incurred by the taxpayer which is in the direction of structural changes rather than functional purpose, then such expenses are held as capital in nature which is non-deductible (Sadiq, 2014). The taxpayer Ruby Pty Ltd incurred the compensation payment and the same cannot be held for deductions. The taxpayer incurred expenses that were entirely incurred for the structural purpose instead of occurring it for functional purpose. The expenses represented capital in nature and hence no deductions will be allowed to Ruby Pty Ltd.
d. As stated by the Australian Taxation Office accounting provision expenses is regarded as non-deductible over the eligible time period. In order to be eligible for deductions under “section 63” of the Act, the expenses must exist before considering the same as the allowable deductions. A taxpayer is entitled to obtain the deductions under “subsection 63 (1)” provided the taxpayer has write off the expenses (Woellner et al., 2014). In the present situation of Ruby Pty Ltd the company has made a provision of $100,000 in the accounts during the year ended 30 June. Accordingly, expenses related to provision is non-allowable for claiming deductions because they are not incurred in the course of obtaining the taxable income and not allowed for deductions under the positive limbs of “section 8-1 of the ITAA 1997”.
e. Expenses or losses that are preliminary in beginning the revenue producing business activities that are not incurred in the course of business activity is not allowed for deductions under the positive limbs of “section 8-1 of the ITAA (1997)”. Citing the court judgement in “Softwood Pulp & Paper v FCT (1976)” the company has occurred spending for feasibility purpose and certain other spending’s to determine whether to begin the manufacturing of the paper mill (Pinto, 2013). The taxation commissioner verdict stated that the expenses occurred by taxpayer for the feasibility purpose is non-allowable deductions. This is because everything that is was performed by the taxpayer was entirely preliminary in nature prior to the beginning of the revenue producing activities.
In the present situation of Ruby Pty Ltd, the business reported an expenses of $220,000 for conducting the investigation of understanding the possibility of entering in the car manufacturing industry. The expenses that were occurred by Ruby Pty Ltd was considered as preliminary in the commencement of the business activity and hence the investigation expenses were occurred in the direction of producing the assessable income. No deduction will be allowable to the taxpayer for the market investigation purpose under “section 8-1 of the ITAA 1997”.
References:
Ball, R., Gerakos, J., Linnainmaa, J. T., & Nikolaev, V. (2016). Accruals, cash flows, and operating profitability in the cross section of stock returns. Journal of Financial Economics, 121(1), 28-45.
Barkoczy, S. (2014) Foundations of taxation law.
Barth, M. E., Clinch, G., & Israeli, D. (2016). What do accruals tell us about future cash flows?. Review of Accounting Studies, 21(3), 768-807.
Bushman, R. M., Lerman, A., & Zhang, X. F. (2016). The changing landscape of accrual accounting. Journal of Accounting Research, 54(1), 41-78.
Coleman, C., & Sadiq, K. (2013) Principles of taxation law.
Gordon, E. A., Henry, E., Jorgensen, B. N., & Linthicum, C. L. (2017). Flexibility in cash-flow classification under IFRS: determinants and consequences. Review of Accounting Studies, 22(2), 839-872.
Grange, J., Jover-Ledesma, G., & Maydew, G. (2014) principles of business taxation.
James, S. (2014) The economics of taxation.
Jover-Ledesma, G. (2014). Principles of business taxation 2015. [Place of publication not identified]: Cch Incorporated.
Kenny, P. (2013). Australian tax 2013. Chatswood, N.S.W.: LexisNexis Butterworths.
Krever, R. (2013). Australian taxation law cases 2013. Pyrmont, N.S.W.: Thomson Reuters.
Morgan, A., Mortimer, C., & Pinto, D. (2013). A practical introduction to Australian taxation law. North Ryde [N.S.W.]: CCH Australia.
Nallareddy, S., Sethuraman, M., & Venkatachalam, M. (2017). The changing landscape of accrual accounting: Implications for operating cash flow predictability.
Pinto, D. (2013). State taxes. In Australian Taxation Law (pp. 1763-1762). CCH Australia Limited.
Sadiq, K. (2014) Principles of taxation law.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2014) Australian taxation law select.
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