 Most of this information comes from the tax guide for small business for individuals who use Schedule C Publication 334 tax year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused online. One income, remember in the first half of the income tax formula is in essence an income statement, although it's just an outline and a scaffolding, other forms and schedules flowing into it. For example, the Schedule C, the business income, which is in essence an income statement in and of itself, income minus expenses, the net then, net income flowing into the income line of the income tax formula. This is the first page of the form 1040. The Schedule C would flow into the Schedule 1, which would then flow into the first page of the 1040 here on line eight. This is the Schedule C profit or loss from business where we can see we have an income statement in essence, income minus the expenses or business deductions. So we're continuing on with our discussion of accounting methods. Remember the two methods you wanna keep in mind are gonna be the cash method and then the accrual method. Most other methods can be thought of as kind of a combination between the two. In other words, those two methods aren't really opposites from each other because you can think of a method where you're basically using pieces. You used a piece lost? Of an accrual method and a cash method. And even if you're on a cash method, you're gonna be forced even then to use some accrual concepts as we discussed when you're doing like capitalization of property, plant and equipment, for example. Also note that you wanna make sure that you get your accounting method properly recorded when you first set up your Schedule C on the first tax return because although you have a pretty fairly wide leeway to pick the accounting method, you want to use once chosen, it's difficult to change the accounting method because the IRS wants consistency with the accounting method. If you were to change the accounting method, going back and forth from a cash to an accrual method, then you can kind of manipulate the timing of the income and expenses and you can try to do some tax manipulation in that case. So the IRS wants to limit that by saying you can choose what methods you want, but then in essence, you keep to that method. And of course, there are some circumstances where the IRS might require say an accrual method in some cases, for example. All right, so now we're on a combination method. So you can generally use a combination of cash, accrual and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. So the consistency is once again, the key component here. However, the following restrictions apply. If an inventory is necessary to account for your income, you must generally use an accrual method for business and sales. So in other words, the inventory, if you're dealing with inventory, you've got to be careful on the method that you're going to choose because you might be able to kind of be under the threshold where you're required to report on a accrual method, but generally you may be required to report on an accrual method if you have inventory because reporting inventory is an accrual thing, meaning when you buy the inventory, if you were on a cash method, you would just expense it when you buy it. But if you're holding onto a substantial amount of inventory, it makes sense to put it on the books as an asset and putting it on the books as an asset is an accrual type of thing. We then expense it when we sell the inventory in the form of the cost of goods sold. So that would mean that you would have to kind of account for that inventory situation on an accrual basis generally so that we can match up the cost of the inventory that was sold, usually the biggest expense if you're just buying and selling inventory with the timeframe that you earn the revenue. Otherwise what would happen is you might have bought the inventory last year or two years ago and then if you expensed it two years ago, you're not matching the expense of the inventory to the revenue that was generated. In the current year, when you actually sold the inventory, that's the idea, we wanna match those two things up generally. So you can use the cash method for all other items of income and expenses. So notice that you might, that's kind of a hybrid kind of method where you can see that would be practical in a lot of small businesses because a lot of the expenses that you have for small businesses, you might try to rely on bank feeds, for example, in order to record them. So you have electronic transfers, you might try to set up your QuickBooks file or something like that so that you can record all the outflows with basically bank feed type of transaction, which is in essence a cash-based kind of system. So then if you use cash method for figuring your income, you must use the cash method for reporting your expenses. So you've gotta be matching the idea here is that we wanna be matching the income and the expenses in the same time period. In other words, the income that you consumed Money, money, money, money, money, money should be matched to the revenue that you consumed it to generate. You know, that's the matching principle which the accrual is better at doing than the cash-based system, but you want some consistency with those methods. If your method is altering them more than a cash-based system to be out of whack, you would think that would not be typically good from a bookkeeping standpoint and not what the IRS is looking for here either, I would think. So if you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. So if you use a combination method that includes cash method, treat the combination method as the cash method. Now note this gets a little bit confusing because a lot of times when people think of the difference between a cash method and accrual method, we kind of think that every transaction is gonna be different between an accrual method. So in other words, if you set up your expenses, like a lot of small businesses do, to be paying when they clear the bank, when you do an electronic transfer, you could say, okay, that's clearly a cash method in that you're letting the transfer of the cash drive when you're going to be recording it. But if you recorded that transaction on an accrual-based method, you would mainly have the same transactions there. In other words, if you paid the phone bill because and you paid it through a bank feed when you paid the phone bill, then you would record the expense at the point in time you paid it based on a cash-based method, but you would also be recording it at the point in time you paid it generally because it's pretty close to the time that you consumed the use of the phone on an accrual-based method. It's just for different reasons. On a cash-based method, you would be recording it at that point in time because you paid the cash on an accrual method. You would be recording the expense at that point in time because it's close to the point in time that you actually consumed the consumption of using the telephone. It's only when those two things are not connected. They're not close to each other that you're gonna have basically a difference in reporting of the timing of the expenses and a similar kind of thing on the income side. Okay, so continuing on, inventories. Generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory and use an accrual method for purchase and sale of merchandise. So as we saw, the inventory is often an issue because it's an accrual component. When you put it on the books as an asset, instead of just expensing it, when you pay for it, you're doing an accrual thing. When you record the expense of cost of goods sold, when you sell the inventory, as opposed to when you bought the inventory, you are once again doing an accrual type of thing from an income statement side of things. We wanna be matching up the revenue that was generated from the sale of inventory and the expense that cost a good sold of the inventory.