Happy holidays to all! It’s time to relax, recharge and reflect. I initially planned to write some tax tips as a closing of 2018 like income splitting, passive income, etc. But, there are way too many articles talking about those changes and confusion happened in 2018. Let me write something different then. It is about deferred income.
Quite often, business owners are familiar with gross income and net income.Gross income is the total revenue generated from a business’s sales (either services provided or products solde). Net income is the residual after that revenue minus total expenses. As a result, business owners use those two as key indicators on performance assessment.
Is there anything wrong?
Yes/No/Maybe.
Yes. Likely, gross income may include deposits that are received but not earned yet in a year. As a result, for those businesses that report their income for tax purpose may pay tax up front instead of delaying tax on the revenue until it is earned. On the other hand, when comparing to the benchmark/industry standards, business owners may be misled by the KPIs that are not accurately applied.
No.If the businesses recognize the revenue only when it’s earned. Simply saying, when the services have been successfully provided/products are delivered, you can book those sales in gross income.
Maybe. In some cases, businesses have been “consistently” recognizing deposits as income once they are received. As a result, the gross income has been inflated. The benefit for startups is that “inflated” income presents a very strong sale when pitching to investors. However, revenue stream/business model will be scrutinized by investors.
Here are some examples of deferred income;
Student tuition that is paid but classes/programs have not commenced;
In professional services industry, retainers are usually required for future services to be rendered;
Customers deposits that are paid ahead but services are not provided/project has not been completed;
Rental deposits as security when entering into a lease with tenants;
Is it very important? Yes. Having an accurate income ready is the first step in your tax filing. Also, putting deposits that have not earned in the right place on the financial statements will allow businesses to have a clear picture of income streams for its fiscal period and furthermore help businesses delay paying tax on the income that has not earned yet.
Saving tax is simple and the first step is to pay attention to your financial.
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