Must the cash basis be used? - Landlords Financial | Bookkeeping Services Manchester

For UK unincorporated businesses, the cash basis is now the default method for calculating taxable profits. Under this basis, income is taxed when received and expenses are deducted when paid, therefore there is no need to take into account debtors and creditors, prepayments or accruals. A further advantage is that, as income is only taken into account when received, relief for bad debts is given automatically. Capital expenditure is deducted as an expense, unless the capital expenditure is of a type for which relief by deduction is specifically disallowed under the cash basis (e.g. cars). Most sole traders and partnerships comprising entirely of individuals automatically fall within the cash basis, unless they opt out.

However, not every business can use the cash basis and, even where it is available, some may deliberately choose to remain on the accrual basis.

Excluded businesses

Under the accrual basis of accounting, income and expenses are recorded when earned or incurred, regardless of when the money is received or paid. The accrual basis must be used where a business is excluded from being allowed to use the cash basis. In practice, this applies where a business falls into one of HMRC’s excluded categories. If a trader is excluded, the accrual basis is not a choice – it is compulsory. Common examples of excluded traders include limited companies and LLPs. Certain farming and creative businesses using specific tax reliefs (e.g. profit averaging or herd basis) are also not eligible, neither are partnerships that include a corporate partner. Businesses where the structure or circumstances mean that cash accounting is not appropriate are also required to use the accrual basis, e.g. where financial statements are prepared in accordance with International Financial Reporting Standards.

Opting out

However, a business does not have to follow the cash basis. For some businesses, preparing accounts on the accrual basis may be beneficial.

A business may wish to opt out if the business:

· Works on long-term projects or has significant work in progress. The accrual method helps in tracking costs and revenues throughout the project lifecycle, ensuring better financial management and planning.

· Holds a large volume of stock. Such high stock businesses often have significant fluctuations in the level and amount of stock. The accrual basis enables the business to calculate profit margins and stock turnover ratios more accurately.

· Gives customers credit. Accounting on the cash basis will not show any bad debts whereas the accrual basis does.

· Buys assets or stock on credit. Under cash accounting, such assets are not eligible to claim tax relief until payment is made which could significantly delay tax relief on large purchases.

· Plans to incorporate. Accounts prepared using the cash basis will need to align with company accounting using the accrual basis from the first year of incorporation. Accounts prior to incorporation will need to be carefully prepared to ensure no overlap in figures.

· Needs financial statements for loans or grants. Lenders and investors usually require financial reports prepared on an accrual basis because this basis shows the financial health of the business more clearly. The cash basis does not show debtors or creditors. If there are outstanding invoices at the year-end, then the cash flow may not be adequate and investors will want to know whether their money is secure.

Must the cash basis be used? - Landlords Financial | Bookkeeping Services Manchester

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