In the Autumn Statement 2023 an announcement was made that, for unincorporated businesses, Cash Basis Accounting would become the default for reporting profits on Self Assessment rather than Accruals Basis Accounting.
So, what does this mean? And is it a good thing?
Understanding Cash Basis Accounting v Accruals Basis Accounting
First, lets clarify a couple of concepts:
– Firstly this applies to unincorporated businesses – Sole Traders and Partnerships – only. It doesn’t apply to Companies who must, in all circumstances, use Accruals Accounting.
– Secondly, this is accounting for Self Assessment, that’s to say tax on profits. Cash Basis Accounting shares a very similar name with the Cash Accounting Scheme for VAT which is a completely different and separate concept, available to all bushiness subject to turnover thresholds – there are no Autumn Statement changes to VAT Cash Accounting Scheme.
So the choice for an unincorporated business is now Cash Basis Accounting or Accruals Accounting. Let’s look at the difference.
– Cash Basis Accounting – transactions are reported on your tax return by date of payment or receipt
– Accruals Accounting – cash transactions are adjusted for stock (goods purchased but not used), debtors (amounts owed to you), and creditors (amounts you owe to people). This is the traditional approach to accounting, mandated by Accounting Standards and UK GAAP (Generally Accepted Accounting Policies), and the way accounts were always prepared and profits reported.
Let’s look at an example, Ray who owns owns a manufacturing business:
| Ray’s Manufacturing Business | Accruals Basis Accounting | Cash Basis Accounting | |||
| Year 1 | Year 2 | Year 1 | Year 2 | ||
| Sales income received | £ 70,000 | £ 90,000 | £ 70,000 | £ 90,000 | |
| Debtors at year end (owed by customers) | £ 20,000 | £ (20,000) | £ – | £ – | |
| £ 90,000 | £ 70,000 | £ 70,000 | £ 90,000 | ||
| Purchases paid for | £ 60,000 | £ 14,000 | £ 60,000 | £ 14,000 | |
| Stock in hand at the year end | £ (20,000) | £ 20,000 | £ – | £ – | |
| Creditors (owed to suppliers) | £ 7,000 | £ (7,000) | £ – | £ – | |
| Overheads | £ 10,000 | £ 10,000 | £ 10,000 | £ 10,000 | |
| £ 57,000 | £ 37,000 | £ 70,000 | £ 24,000 | ||
| Profit | £ 33,000 | £ 33,000 | £ – | £ 66,000 | |
Using Accruals Basis Accounting Ray reports a profit of £33,000 each year. Using Cash Basis Accounting Ray reports no profit in year 1, and £66,000 of profit in year 2.
If Ray had used Cash Basis Accounting, then there are several anomalies to note.
- His cash flow doesn’t change in any way, just reporting.
- The break even in the first year won’t see him in good stead with his lenders, eg bank overdraft or if he seeks credit to buy an asset.
- Using Cash Basis Accounting, and assuming no other income, he wastes his Personal Allowance in year 1 and pays tax at 40% in year 2 – by contrast with Accruals Basis Accounting he would retain the benefit of his Personal Allowance and be a Basic Rate taxpayer each year, so his taxes would be less.
- Finally, under Cash Basis Accounting Ray’s accounts don’t really give him a fair picture of how well his business has performed.
It’s an extreme example, but illustrates why Cash Basis Accounting may not always be beneficial, and the potential benefit of Accruals Basis Accounting in properly matching debtors, creditors and stock.
By contrast, suppose Ray was a taxi driver – he has no debtors as customers pay at the end of each journey, no creditors as he pays all his expenses as he goes along, and no stock. Under Accruals Basis Accounting and Cash Basis Accounting his profits would be exactly the same.
So what changed in the Autumn Statement?
Currently, you can only start to use Cash Basis Accounting if your turnover is less than £150k, and you must come out of it if your turnover is over £300k. From April 2024 these thresholds are abolished.
Additionally at present Cash Basis Accounting has to be opted into, with Accruals Basis Accounting being the default – this will swap from April 2024 – Cash Basis Accounting will be the default and businesses will need to elect to use Accruals Basis Accounting.
Finally, at present there are some restrictions if you use Cash Basis Accounting around deducting interest / finance costs and around offsetting loses these restrictions are abolished from April 2024.
In Practice
Although called simplification, it can be seen that for some businesses Cash Basis is simpler, other businesses it causes distortions, maybe severe, in profit.
Generally, the businesses suited to Cash Basis Accounting are probably using it by default as they have no debtors, creditors or stock – a typical cash business. By contrast businesses who give and take credit, or who hold fluctuating stock, will find that Accruals Basis is a more objective measure of their business performance and better for tax accounting.
You’ll need to take advice if you are unsure.