Introduction

For most businesses, income is recognised when it is earned — the accrual basis. For certain professionals, the Income Tax Act provides an election to use the billed basis instead — recognising income only when an invoice is rendered, not when the work is performed. The choice between these two methods determines when income is taxed — and for professionals with significant work in progress, the timing difference can be material.

Who Can Use the Billed Basis

The billed basis election is available to professionals in prescribed categories: accountants, dentists, lawyers, medical doctors, veterinarians, and chiropractors. Architects and engineers are not on the prescribed list and must use the accrual basis.

For those who qualify, the election is made by filing the T2 without accruing unbilled WIP as income. The election is available annually and can be changed, but changing from billed to accrual basis requires bringing the accumulated WIP into income in the year of change — a potentially significant one-time income inclusion.

How the Billed Basis Works

Under the billed basis, a law firm that has performed $120,000 of work on a matter but has not yet issued an invoice recognises $0 of income from that matter. When the invoice is issued — next month, next quarter, next year — the $120,000 becomes income at that point.

The practical effect: at any fiscal year end, the corporation's unbilled WIP is not included in income. For a practice with $200,000 of year-end WIP, the billed basis election defers $200,000 of income from the current year to the following year (or when billed).

How the Accrual Basis Works

Under the accrual basis, work performed but not yet billed is recognised as income as it is performed — typically based on a percentage-of-completion estimate or a WIP calculation. The year-end unbilled WIP is included in income whether or not an invoice has been issued.

For a practice with $200,000 of year-end WIP, the accrual basis includes that $200,000 in current-year income — generating current-year corporate tax on it at the small business rate ($24,400) before the money has been collected.

Which Is Better?

For practices with consistent year-over-year WIP — the $200,000 WIP at year end is roughly the same every year — the billed vs. accrual difference is largely a timing choice. The deferral in year one of using the billed basis is a one-time benefit; in subsequent years, the prior year's deferred WIP is billed and included while new WIP is deferred, producing roughly the same income each year under both methods.

The billed basis is more beneficial when:

•  WIP is growing year-over-year (the deferred amount is larger each year)

•  The practice has cash flow sensitivity to paying tax before billing

•  The fiscal year end falls in the middle of large active matters

The accrual basis may be preferable when:

•  The practice is winding down (WIP is shrinking — switching to accrual at that point would accelerate income)

•  The practice has very short billing cycles and minimal year-end WIP

The Transition Cost

Switching from billed to accrual basis — whether by choice or because the practice no longer qualifies — requires bringing the accumulated deferred WIP into income in the year of change. For a practice that has used the billed basis for ten years and has $400,000 of accumulated deferred WIP, switching to accrual adds $400,000 to taxable income in the transition year.

This transition cost is one reason practices that start on the billed basis tend to stay on it.

When to Speak With a CPA

For a new professional corporation, the accounting basis election should be made deliberately at the first T2 — not by default. A CPA can model the first-year deferral benefit and help choose the method that best matches the practice's billing cycle and cash flow structure.

Rotaru CPA advises professional corporations on income recognition method selection and ongoing compliance. Book a consultation to review your corporation's accounting method.