Is the cash basis right for you?
Traditional accruals basis or cash basis accounting?
Ten years ago, HMRC introduced the cash basis accounts preparation system for the self-employed to calculate their trading profits. It’s voluntary, but take-up remains low, so HMRC plans to expand its availability. Why might businesses prefer traditional accruals basis over cash basis accounting?
Currently, cash basis accounting can only be used if a business’s annual turnover doesn’t exceed £150,000. HMRC is now considering increasing this limit to £1.35 million – in line with the VAT cash accounting scheme – as well as potentially making the cash basis the default method for calculating trading profits. Businesses would have to opt-out rather than opt-in, as they do now.
Why opt for cash basis accounting?
Some businesses find the cash basis to be helpfully simple. There is no need to take account of debtors, prepayments, creditors and stock. Most equipment purchases are simply deducted as an expense, and the complexities of capital allowance claims are avoided.
It does, however, suffer from two significant restrictions:
There is also less scope for tax planning with the cash basis than with the accruals basis. Using the traditional method, a capital allowance claim, for example, can be restricted to maximise use of the personal allowance. Not so with the simplified cash basis.
The accruals basis alternative
Beyond tax, there are also several other reasons for preferring the accruals basis for accounts preparation. Cash accounting does a less accurate job of matching revenues earned with money laid out for expenses, with the result that accounts may not provide a true picture of a business’s performance. Such simplified accounts might turn out to be inadequate when it comes to applying for a business loan or a personal mortgage, for instance.
For larger concerns, accurate accounting becomes even more important. HMRC may find that expanding cash basis availability proves less popular than it hopes.