Summary Of The Changes
Changes have come into force from 6 April 2024 which impact all unincorporated trading businesses in the UK i.e. Individuals who are self-employed or a partner in a partnership (including limited liability partnerships).
The turnover thresholds for businesses to use the cash basis have been removed entirely.
The cash basis is now the default method of calculating taxable trading profits.
Previously, the default was the accrual method, but now the changes are in force, businesses need to opt out of the default on their tax return to continue using the accrual method if that is their preferred method.
Cash vs Accruals Basis
Cash Basis for Accounting
Under the cash basis, you record transactions only when there’s an actual inflow or outflow of cash.
Revenue is recorded at the time of cash receipt, and expenses are recorded when they are paid.
One of the disadvantages of the cash basis is it doesn’t adhere to normal accounting standards, and you may be required to prepare accounts under these accounting standards for another purpose. For example, when trying to raise finance, lenders may want to see a full set of UK Generally Accepted Accounting Principles (GAAP) accounts with a balance sheet to demonstrate the strength of the business to borrow money. Also, the timing of receipt of monies owed to, or payment of monies owed by the business, can have a distortive effect on profits, causing peaks and troughs in profits from year to year and resultant changes in tax payment profile, including impacts on payments on account, as well as possibly causing issues with using these figures for external finance, including personal mortgages etc.
Accruals Basis for Accounting
Accruals accounting recognises transactions when they are incurred or earned, regardless of when the cash is received or paid.
This means you usually record income at the time you invoice the customer, rather than when you receive payment for the invoice (which could potentially be months later).
A benefit of accrual accounting is that it provides a more accurate picture of financial performance and position.
The accounts more accurately show when income and expenses actually occurred each month as well as the debtor and creditor positions at the end of the period.
It’s beneficial from a management perspective, and to understand how your business is performing, to use this method when selling stock to align revenues with their related expenses – the cost of goods sold are recorded at the same time as the revenue from the goods.
The downside to accrual accounting is it requires more complex bookkeeping, and can involve estimates and adjustments for items such accruals, prepayments and depreciation.
Accrual accounting is generally required in order to comply with accounting standards such as UK GAAP and International Financial Reporting Standards (IFRS), making it suitable for larger and more complex businesses that must adhere to these standards when preparing financial statements, or those where they expect to need external finance.
What does this mean for you?
If you’re self-employed (a sole trader) or you are a partner in a partnership, from the 2024/25 tax year onwards, the cash basis has become the default method of preparing taxable profits on your tax returns.
This doesn’t mean you’re required to adopt the cash basis if you’re currently preparing accrual accounts.
We will review what, on balance, we recommend is best for you and your business, and if you decide to continue using accrual accounting, the only change required when filing your tax return will be to select the option to opt out of the default cash basis.
If it is deemed beneficial to switch from accrual accounting to cash basis, there will be some income and expense adjustments required in the first year to ensure we account for all income and expenses correctly.
For example, payments made to your suppliers in the cash basis period might include settlement of amounts owed for purchases already accounted for in the previous tax year. So, these payments will need to be deducted from the cash basis accounts otherwise the expenses will be counted twice.
You will also need to be mindful of the impact of the timing of monies coming in and going out, especially around the year end.
If you have any questions on these changes then please do not hesitate to contact one of the CRM team.
