New options for Cash Basis accounting

A new consultation is looking at ways in which Cash Basis might be extended. Accountant KAREN PORTER helps to explain what may be in store.

Many clients speak to me about the Cash Basis scheme and ask about its advantages in relation to Accrual accounting. We’re actually at an interesting turning point, as change seems to be afoot, so there couldn’t be a better time to take a look at this issue in a little more detail.

The Cash Basis scheme was set up to enable small businesses to account for income and expenses when they receive payment from a customer or make a payment for an expense (compared with the Accrual scheme where income and expenses are are recorded when the invoices are raised). The scheme was introduced in 2013/14 and is optional for small businesses.

HMRC have recently launched a new consultation on extending the Cash Basis for self-employed taxpayers. The consultation was published with the Budget 2023 documents and requested views on options to extend and simplify the self-employed Cash Basis. As the consultation deadline was the 7 June, the results of this are expected imminently.

The options set out by the government include:

• Increasing the thresholds so that cash accounting can be used by more businesses
• Making cash accounting a default option for trading income
• Possibly relaxing current restrictions on using relief for losses made in the cash basis

Who can use the scheme currently?

At the moment, you can use the cash basis if you run a small business, e.g. sole trader or partnership, where you have a turnover of £ 150,000 or less per annum. It should be noted that if you have more than one business, then you must use cash basis for all your businesses and the combined turnover must be less than £150,000.

You can stay in the scheme up to a total turnover of £300,000. Once this limit is currently exceeded, you need to use the traditional accounting method for the next return.

Limited Companies and Limited Liability partnerships cannot use cash basis. There are also certain types of businesses which cannot use cash basis too and there is a full list on HMRC website.

Which is better? Cash Basis or Accrual?

Advantages of Cash Basis over Accrual Accounting:

• Simple for calculating tax and gives an accurate picture of how much cash is on hand
• Offers particular benefits to those who often experience a long delay between raising invoices and receiving payment (e.g. barristers/solicitors)
• Less work – recording receipts and payments and not recording invoices

Disadvantages of Cash Basis over Accrual Accounting:

• Cash Basis may show profitability, but accrual accounting provides a more accurate indication of business performance over time.
• Accrual Basis shows exactly when income and expenses occurred, making it a better way of forecasting future profitability and helping a business make important financial decisions.
• The deduction for interest and other finance costs paid is limited to £500 under the cash basis, whereas under the accruals method there is no monetary restriction.

If you decide to switch from one accounting basis to the other because you cross the £150,000 limit, or elect not to use the accruals basis, the legislation requires you to make a transitional adjustment. Before considering any such change you should seriously consider contacting your accountant or tax adviser.