Cash accounting – an alternative to accruals accounting? And what about accounting software?

English: Accounting machine from UK manufactur...

English: Accounting machine from UK manufacturer Powers-Samas. (Norwegian Technology Museum, Oslo.) (Photo credit: Wikipedia)

In Ireland and the United Kingdom (and maybe come other countries) it has always been possible for smaller business to pay VAT based on cash received rather than on an accruals basis.  You probably know what the accruals concept is, but if not click here. When I teach accounting or prepare accounts, the accruals concept is used almost without exception. The profit & loss account (income statement) and balance sheet (statement of financial position) will definitely use the accruals concept. In fact, these  financial statement often take a different name and format when prepared for a cash-based business. For example, when I teach how to prepare the financial statement of not-for-profit organisations such as clubs, we often refer to a “Receipts and Payments Account” and a “Statement of Affairs”. The former is like an income statement, but is based on cash records; the latter is a list of assets and liabilities and will normally draw on the accruals concept.

From April 1st 2013, the UK tax authorities permits smaller unincorporated businesses to use a cash based accounting scheme where the turnover is less than £77,000 (see here for more detail). I’m not a UK tax expert, but from my reading about the topic on the web, the “income” of a small business will be the cash received, and the “expenses” will be cash paid for business expenses. This sounds like a reasonable effort to simplify the tax system for the smallest of businesses. The accruals concept may not be that relevant to many of these businesses as, for example, they may have few assets (to depreciate) and receive payment for most work as soon as it is done. So all fine? Well apparently, many accountants protested this new scheme, and that’s not surprising given how the accruals concept is engrained not only in the teaching of accounting, but also in accounting regulations. As a management accountant, I would always encourage the smallest of businesses to think in cash terms – it is easier for business owners with little accounting skills to understand. But I do see one big problem with this scheme in the UK. It centres around what happens when turnover exceeds £77,000. Once this happens, the business must revert to accruals accounting. This would cause much confusion if a business is using accounting software.  Normally, accounting software incorporates accruals accounting, but some also support cash accounting  in the way described here. I’m not 100% sure, but I would imagine if you set up software to work in one method, it may not be that easy to switch. So even though this cash scheme is easier and optional for small UK business, if they use accounting software (and more and more do) then it is probably best to stick to accruals accounting.

Tags: ,

About martinjquinn

I am an accounting academic, accountant and author based near Dublin, Ireland.

2 responses to “Cash accounting – an alternative to accruals accounting? And what about accounting software?”

  1. acctsolution says :

    Thanks for sharing nice information with us.Excellent information provide for us. Your work is really being appreciated by someone.

  2. Nick Berry says :

    Great info guys. I’ve got a small business and the accounting side’s always stumped me. I started using KashFlow software earlier this year. Luckily, they’ve got blogs on this sort of stuff and I understand how to handle my accounts a lot more. The more business owners are able to understand their accounts, the better!

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: