Accounting Methods in Ecommerce

Main Accounting Methods in Ecommerce

Online shopping has now become easy and commonplace for the buyer, but this impression actually masks the whole complexity of ecommerce businesses management and at the same time underestimates the unique transformation of our lives that’s happened thanks to ecommerce evolution. While searching, choosing, buying and paying for things and services has become much easier for the clients, ecommerce business owners have harvested lots of opportunities entwined with new challenges. 

Ecommerce does provide the potential of a broader customer base, which might be a desired asset for many starting businesses. However, facing up to some challenges of implementing online retail strategies and ecommerce accounting is the inevitable pay for the opportunity. If we look closer at accounting for ecommerce, it all boils down to making the right choices about where to look for assistance and at what moment wearing all hats might be a little too much on the plate of an ecommerce business owner.

It shouldn’t sound discouraging, after all 41% of small business owners and managers handle accounting and finance themselves, according to the survey carried out with 1085 managers and owners of US small businesses with at least one employee. The question here is “what is more efficient for this particular business at this stage of development?” In this article we are going to look into the main accounting methods for ecommerce and define at what stage of ecommerce business development and under which circumstances this or that accounting method is more appropriate, effective, and compliant with the regulatory requirements.


1. Specific requirements of ecommerce accounting

2. Basic accounting methods for ecommerce

Specific requirements of ecommerce accounting

Saying that ecommerce accounting is totally different from traditional accounting would be an overstatement as we understand that they both have a considerable amount of the same procedures, practices and goals, with the main one – keeping the business solvent. However, ecommerce does have some peculiarities, complicating accounting. If we take a brief look at these challenges, it might help to understand where to shift the focus while organizing your ecommerce accounting.

The most typical differences and  challenges of ecommerce accounting are the following:

  • Ecommerce platforms involvement

On the one hand, ecommerce platforms like Amazon, eBay, Etsy, Walmart, Shopify and others give a huge boost to a starting ecommerce business by allowing the entrepreneurs to access their ample resources, be it a customer base or a set of tools to build an online shop, or both. 

On the other hand, all these ecommerce platforms have their rules to follow and fees to pay, confusing the traditional direct money flow from customers to sellers. 

Using ecommerce platforms and, as a consequence, payment gateways results in extra fees charged by the former. When starting an ecommerce business, it’s crucial to account for all the fees and charges that come along the way, as well as to get familiar with all the reporting functions and regulations of the platforms one works with.

  • Tax implications

Facilitation of appropriate sales tax compliance can get a bit tricky for ecommerce business owners, as sales tax regulations vary by state. The general practice is that sales tax should be paid to the state in which delivery occurs. If a business has its primary operations in a different state and has the so-called “sales tax nexus” with that state, the company isn’t responsible for collecting the sales tax in the state in which the delivery occurs. In this case, the sales tax is the responsibility of the customer. 

The definition of the sales tax nexus might change from state to state. Establishing the nexus with the state may require certain business activities like having a physical store or reaching some sales threshold, which will result in establishing either physical or economic nexus. 

Income tax deductions is one more aspect to consider, as ecommerce businesses are eligible for deductions for professional accounting services and “home office” deductions.

  • International transactions

Using ecommerce platforms means acquiring international clients, which in its turn entails fees for processing international credit and debit transactions. Ecommerce business owners and accounting professionals need to dig into the most cost-effective ways to keep international clients buying.

  • Inventory Management

Inventory management might be one more hurdle on the way for ecommerce business accounting, especially for medium and large ecommerce businesses. Excluding dropshipping business owners, entrepreneurs should be able to monitor their inventory flow. There are a couple of points that complicate the whole process. 

Compared to traditional brick-and-mortar stores, ecommerce businesses tend to have a much larger volume of inventory dispersed in multiple locations, which makes it difficult to track efficiently and accurately. The complexity of the supply chain with multiple suppliers, distributors and shippers makes it even more confusing. Stockouts, overstocks and inaccurate inventory counts are some of the problems that can be solved with a robust inventory tracking system.

These are just some of the areas that need extra attention when ecommerce accounting is implemented.

Basic accounting methods for ecommerce

Accounting method as such is a set of rules and practices a company follows when reporting its revenues and expenses. When it comes to choosing an accounting method for an ecommerce business, various factors like size, complexity, regulatory requirements, volume of transactions and business development stage are at play here. Ecommerce businesses typically use either cash-basis accounting method, or accrual accounting method.

1. Cash-basis accounting or cash method

The cash-basis accounting is often called straightforward and simple. According to the cash-basis accounting, transactions are recorded when the cash is paid (spent or received). 

According to the IRS, income is recorded when an amount is credited to a business’s account and is available without restrictions. Expenses are deducted in the tax year in which they are actually paid. 

The cash method is mostly used for managing personal finances and by businesses of a certain size. The IRS regulations stipulate that the cash method can be used by companies that meet the gross receipt test. That happens if its average annual gross receipts for the 3 prior tax years were $26 million or less (indexed for inflation). The companies that fail to meet the test should switch to the accrual method. 

Being simple to implement, the cash method can be seen as more flexible than the accrual method, as it allows businesses to record income and expenses when they actually occur, rather than when they are earned or incurred, which can be helpful for businesses that have seasonal fluctuations in sales or expenses.

The drawback of the cash method is it might give an inaccurate picture of a business’s financial health, as it doesn’t account for revenues or expenses that have been incurred but not yet paid or received, which can be a hurdle for businesses that need to track their profitability or debt levels. The cash-basis accounting can either overstate or understate the condition of the business if collections or payments are particularly high or low in one period compared to another.

Now, thinking in terms of ecommerce accounting, the cash method might be a good fit for businesses that have the following features: 

  • Low transaction volume  as it means that it’s much easier to accurately track cash receipts and payments.
  • Short sales cycle,  which guarantees that products or services are sold and paid for quickly, and makes it easier to match revenue with expenses.
  • Simple financial needs such as tracking income and expenses, which  can be met with the help of cash-basis accounting.

The examples of such ecommerce business categories would be small online retailers, service-based ecommerce businesses, freelancers, sole proprietorships and microenterprises, low-volume startups and small niche businesses.  The cash method might satisfy a low-volume startup that doesn’t keep an inventory until and if its annual average gross receipt reaches $26 million.

2. Accrual accounting

Accrual accounting is a more complex accounting method that records income when it’s earned and expenses when they’re incurred, regardless of when cash is actually received or paid. 

According to the IRS, under the accrual method of accounting, income is generally reported in the year it’s earned and expenses are deducted or capitalized  in the year they’re incurred with the purpose to match the income and expenses in the correct year. The accrual method is also required by GAAP

The idea of accrual accounting is to record accruals on the balance sheet that hold the place for upcoming cash events. So, two terms that describe it properly are accounts receivable (reflects the revenue a company has earned but hasn’t yet been paid for) and accounts payable (shows the amounts the business owes but hasn’t yet paid).

Accrual accounting is supposed to be a more accurate method of accounting for a company’s financial health, but it can be more complex to maintain. Consistency of accrual accounting allows comparing financial statements from different periods, which certainly contributes to accurate tracking of financial performance over time. However, accrual accounting requires time commitment and investment in accounting professionals and software.

The accrual method is appropriate for ecommerce businesses that meet the following criteria:

  • High transaction volume, which  means that it can be difficult to track cash receipts and payments. Accrual accounting allows keeping track of all financial transactions, even those not involving cash.
  • Long sales cycle, which makes it difficult to match revenue with expenses. 
  • Complex financial needs such as tracking profitability or debt levels, which can be successfully met by accrual accounting.

A good example of such ecommerce businesses are large-scale ecommerce retailers, marketplace platforms, dropshipping businesses, subscription-based ecommerce businesses, B2B ecommerce businesses and international ecommerce businesses.

A company can adopt accrual accounting as early as at the startup stage and go with it through other stages of development. The companies selling inventory and those with an annual average gross receipt of $26 million and more are obliged to use accrual accounting.

3. Revenue recognition under accrual accounting

There is one more thing that seems logical to delve into when talking about the accrual method – revenue recognition. The revenue recognition principle is supposed to be the pillar of accrual accounting, while it’s not applicable for cash accounting. Essentially, the company recognizes its revenue when the product or service is considered delivered to the customer and the customer has a legal obligation to pay, and not when the cash is received. This principle guarantees that the financial statement of a company reflects its real performance.

If we take a company that sells consulting services, for example, it would recognize revenue when the service is performed, even if the service is paid for later.

On the other hand, if we take a company that sells software and has a monthly plan with an advance payment, it would recognize revenue not when the software is paid for, but when a monthly subscription finishes and the software performed its function. In this case, the money paid in advance would be deferred revenue, or “not-earned revenue”.

If we take it a step further, big ecommerce businesses selling inventory usually recognize revenue when the order is fulfilled and has the status “Shipped”, which makes the whole recognition process even more complex. Fulfillment accounting is the term used to describe this practice, and a problem to be solved by accounting integrations and software. While smaller companies can recognize revenue based on the order dates, big companies tend to use fulfillment accounting to resolve the problem of double entry.

4. Hybrid accounting

Hybrid accounting is essentially not a separate method, rather a combination of cash and accrual methods. Some ecommerce businesses may opt for a hybrid approach and use cash accounting for certain aspects, such as tracking cash flow and managing day-to-day operations, while choosing accrual accounting for reporting financial statements and complying with tax regulations.

Wrapping up

Choosing an accounting method requires a certain amount of consideration, as it’s a serious step that entails many implications for an ecommerce business accounting. Being consistent, accurate and compliant with the regulations, whether with or without the help of accounting professionals and accounting integrations and software, always pays off.

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