Cash Basis vs Accruals Basis
When you speak to someone in business such as bank manager or an accountant, or when signing up for services with HMRC, you may come across the terms cash accounting basis or accruals basis. Understanding what these terms means is crucial, and the answer will tie in with your bookkeeping.
A cash basis means that your invoices and receipts are entered in your online bookkeeping and analyzed using the paid date. An accruals basis uses the tax point on invoices and receipts and the items are analyzed when the transaction is agreed whether there was or was not payment at the same time. One of the two methods must be used and stuck to for the business; the two cannot be mixed.
A cash basis is the simple method and more likely for self-employed individuals or companies that exchange goods and services for money on the same day. They may pay for some goods by credit; i.e. telephone bills are sent out 2 weeks before the direct debit payment is taken, but there will be few of these types of bills. In these cases the telephone costs would be dated as the day the direct debit leaves the bank account. This does mean that in the preparation of annual accounts there will often be no debtors or creditors on the balance sheet. When reviewing your business’ cash and bank on bookkeeping software, the figures will show what is currently available to the business and cashflow can be easily maintained by reviewing those figures and reports.
An accrual basis method takes the date of the invoices issued and receipts received and uses the date on each when reports are being made. This means that if an invoice was due at an accounting year end but was paid after that year end date the annual accounts would show a creditor due on the balance sheet. While over a period this shows an idea of the business performance report figures can show a different figure in the bank than there is, and this will impact a cashflow report.This example will show how the two different accounting methods affect the profit and loss account in a set of accounts.
Imagine for an annual accounting year, the below transactions are the only ones that occurred.
1. £10,000 invoiced for work done, not yet paid
2. £2,500 creditor, still to be paid by the business
3. £6,000 monies received from client; this was a debtor in last year’s accounts
4. £3,000 creditor paid; this was a creditor in last year’s accounts.
Using the cash basis the profit for the year would be £3,000 – the debtor from last year of £6,000 less the creditor from last year of £3,000.
The accrual basis would show a profit of £7,500 – the amount invoiced in the year less the creditor for the year.
This example shows how cashflow reports can be skewed; the business does not have the £7,500 profit available to them at the accounting year end as the debtor and creditor were not cleared then. Tags:
cash accounting, accruals basis accounting, bookkeeping, tax calculations