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What is Cash Basis and Accruals Basis?

Sole traders and partnerships make use of cash basis to shape up their business accounts which in turn helps them fill their self-assessment tax return form to declare their taxable income

Please remember that small businesses either have the accruals basis or the cash basis method to calculate their self-employment profits.

Cash Basis and Accruals Basis of Accounting

What is the Accruals Basis?

The accruals basis is also known as GAAP (Generally Accepted Accounting Principles). The accruals basis deals with basic accountancy principles and records only the receipts and expenses applicable to a particular accountancy year in that year.

Cash basis was introduced in 2013/14 which means that businesses had no other alternative and used only accruals basis to record stock, debtors and creditors. This can be more clearly explained with the help of an example. For instance, if an electronic goods shop Rezo Electronic buys 15 ovens in a particular year. At the end of that year, it manages to sell only 10 microwave ovens. Then as per the accrual basis, only 10 ovens will be treated as purchase while the unsold product will be treated as stock asset for the next year.

What is the Cash Basis?

The cash basis made its debut in April 2013. The primary purpose behind its introduction was to simplify the entire process of filling the self-assessment tax return simple and hassle free for unincorporated businesses (sole traders and partnerships). The primary differentiator for cash basis in comparison to accrual basis is that in cash basis, traders can record transactions (income and expenses) only when they receive the payment for it or make payments for the goods purchased. The cash basis eliminates the need for calculating debtors and creditors at the year-end.

Taking the above example of the electronic goods shop:

Taking the example from above, if an electronic goods shop Rezo Electronic buys 15 ovens in a particular year. At the end of that year, it manages to sell only 10 microwave ovens. Then as per the cash basis of accounting, all 15 ovens would be treated as a purchase during the year given Rezo Electronics has made full payment for the ovens it had purchased during that accounting year. In contrast to accrual basis, there would be no stock asset for the next year.

Who can use the Cash Basis?

As mentioned above cash basis is for sole traders and partnerships. In order to be eligible for cash basis, the sole proprietor and partnerships should have an annual sales turnover not exceeding £150,000 (£83,000 for the 2016/17 tax year). Universal credit (UC) claimants can use the cash basis if their annual sales or turnover is £300,000. Businesses cannot make use of cash basis as soon as their annual sales or turnover exceeds £300,000.

In case a trader or businessman has more than one business and is using cash basis for one business, they are required by law to use cash basis for other businesses as well.

** Please note that there are certain business that are not eligible to use cash basis.

The list of such businesses are as following:

  • Businesses engaged in those in the mineral extracting trade
  • Ministers of religion
  • Self-employed people using the profit averaging election
  • Companies;
  • Businesses dealing in waste disposals
  • Dealers in securities
  • Intermediaries treated as making employment payments
  • Cemeteries and crematoria businesses
  • Lloyd’s underwriters
  • Limited liability partnerships (LLPs)
  • Businesses dealing in lease premiums
  • Businesses which have claimed the Research & Development allowance
  • Businesses which have claimed premises renovation allowance, etc

What Procedures I need to follow to Change from the Accruals Basis to the Cash Basis?

The procedure to be followed to make a transition from Accruals Basis to the Cash Basis are listed as following:

Income generated annually and recorded as per accruals basis but not received until using the cash basis is not eligible to be recorded as per cash basis.

For example, Jerry uses the accruals basis for the tax year 2016/17 and his income at the end of the year comes up to £12,000 inclusive of the £3,000 he is yet to receive. During the preparation for accounts in order to complete his 2016/17 Self-Assessment tax return, he includes his overall sales of £10,000 and records debtors of £1,000. In 2017/18, he decides to switch over to the cash basis and in June 2017 he receives payment for £2,000 for the income that he included in the 2016/17 tax return.

Now as per the cash basis method Jerry is required to record the sum £2,000 when he receives it, but as he is switching from accrual basis to cash basis, this would lead to £2,000 being taxed twice, both in 2016/17 and 2017/18. Therefore, a transitional adjustment is needed to the cash basis income in 2017/18 to reduce sales income by £2,000.

Any expenses incurred using the accruals basis but not paid for until using the cash basis should be omitted as expenses under the cash basis for the simple reason that the tax relief has already been claimed.

Under the accruals basis any closing stock held by the businesses at the year-end has to be treated as an asset and not an expense. Under the cash basis, the stock is deducted as a purchase expense.

If the business is VAT registered and using the cash basis method, then it must record any VAT refunds as income and VAT payments as expenses. Transitional adjustment is required if moving from accruals basis to cash basis.

Capital assets, excluding land, cars, motorcycles, buildings are eligible for capital allowance relief under accruals basis. In an event of the business moving to cash basis, the amount due as capital allowance will be treated as a cash purchase.

What Procedures I need to follow to Change from the Cash Basis to the Accruals Basis?

Sales made under the cash basis and the payment received after moving to the accruals basis has to be included as income in the accruals basis.

Any expenses incurred under the cash basis but not actually paid for until the business moved to the accruals basis, must be deducted under the accruals basis.

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