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, let’s 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 the VAT Cash Accounting Scheme.
So the choice for an unincorporated business is now Cash Basis Accounting or Accruals Accounting. Lets 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 yoga business:
| Ray’s Yoga Business | Accruals Basis Accounting | Cash Basis Accounting | |||
| Income from Classes | £ 25,000 | £ 10,000 | £ 25,000 | £ 10,000 | |
| Income from Retreats | £ – | £ 35,000 | £ 5,000 | £ 30,000 | |
| Income from TTC | £ 18,000 | £ 18,000 | £ 36,000 | £ – | |
| £ 43,000 | £ 63,000 | £ 66,000 | £ 40,000 | ||
| Overheads | £ (5,000) | £ (5,000) | £ (5,000) | £ (5,000) | |
| Retreat Costs | £ (20,000) | £ (2,000) | £ (18,000) | ||
| TTC costs | £ (6,000) | £ (6,000) | £ (6,000) | £ (6,000) | |
| £ (11,000) | £ (31,000) | £ (13,000) | £ (29,000) | ||
| Profit | £ 32,000 | £ 32,000 | £ 53,000 | £ 11,000 | |
Ray gets his income from various streams
- Income from classes – which is reducing as his retreat and teacher training business is expanding
- Income from a retreat which takes place in year two. Deposits of £5,000 are received a year earlier, and a £2,000 deposit on the venue is paid at the same time
- Income from a teacher training course – this takes place over two years, attendees pay up front, and costs of venue hire and faculty lecturers are paid though out the course.
Using Accruals Basis Accounting Ray reports a profit of £32,000 each year. Using Cash Basis Accounting Ray reports £53,000 of profit in year one and £11,000 in year two.
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.
- Using Cash Basis Accounting, and assuming no other income, he wastes his Personal Allowance in year 2 and pays a lot more tax in year 1, including going into the 40% threshold. 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 reporting income and expenses.
By contrast, suppose Ray simply taught classes – he would have no adjustments for deposits or income spreading. 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, but generally for a Yoga teacher running classes only Cash Basis Accounting will be fine, but if there are complexities like retreats and trainings spanning multi years, then a more nuanced approach may be called for.
