Paul L. Caron

Wednesday, May 23, 2007

Dodge on Why the Accrual Method Should Be Eliminated

Joseph M. Dodge (Florida State) has published Exploring the Income Tax Treatment of Borrowing and Accruals, or Why the Accrual Method Should Be Eliminated, 26 Va. Tax Rev. 245 (2006).  Here is the abstract:

In this article, Dodge examines the tax treatment of borrowing under the income tax. The current income tax treatment is contrasted with a cash-method treatment, which is inclusion of borrowed funds coupled with the deduction of the principal and (where appropriate) the interest. (An alternative would be exclusion of the borrowing coupled with disallowance of both principal and interest.) The current approach is appropriate in the case of debt-financed investments (capital expenditures) that produce fully-taxed income, but the cash-method approach is right for debt financed-expenses (and lightly-taxed investments). Dodge discusses the accrual method of accounting for liabilities to pay future expenses, and concludes that cash-method treatment is theoretically correct in most circumstances.

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Dodge does his usual meticulous, thought-provoking job of dissecting an issue. And on its face, his proposal to do away with accrual accounting principles for federal income tax purposes would seem to annihilate a lot of mischief that has gone on over the years (especially the last 10 or so).

But Dodge's basic critique of the so-called borrowing exclusion -- namely, that the repayment obligation, to a borrower, is not a present economic loss that offsets the proceeds of the borrowing -- simply ignores economic reality.

Posted by: Jake | May 23, 2007 6:58:30 PM