All businesses have to prepare their accounts according to Generally Accepted Accounting Practice (GAAP) and since 2005 businesses can voluntarily follow International Financial Reporting Standards (IFRS). UK GAAP is gradually aligning itself to international GAAP, this is not necessarily such a good thing for small business.

In his feature last week 'Accounting standards for SMEs' [1], AccountingWEB contributor Simon Sweetman asked whether is was right that the International Accounting Standards Board, and Urgent Issues Task Force should be able to directly effect the amount of tax paid by an SMEs. He was of course, referring to the fact that if it were not for International Accounting Standard (IAS) 18, we would never have had Application Note G to FRS 5, and UITF 40.

In the debate that followed, Martin Foley suggested that Simon might like to back a campaign for a return to "cash accounting" for small businesses. If businesses adopted this method they would no longer be at the mercy of the international accounting standard setters, there would be no UITF 40 and no problems in trying to decide whether to adopt UK or International Standards.

Cash accounting for the smaller business actually makes a lot of sense. It makes bookkeeping and basic accounts preparation very simple. Everyone understands it and most people can keep a simple cashbook. Many businesses are cash accounting for VAT in any case, and this creates a certain amount of confusion for many proprietors.

There are a whole range of trades and professions who are already virtually cash accounting such as teachers, plumbers and gardeners. Most of these are quite probably bemused that you adjust their accounts for prepayments, accruals and depreciation. Prepayments nearly contra out accruals, and depreciation gets added back for tax in any case. What is the point for true and fair accounts for these businesses; they just want "tax accounts"?

There is clearly an argument for "simple accounts" for small business, especially since HMRC have been looking at methods to cut red tape. The irony of UIFT 40 is of course that it has served to greatly increase red tape and cost most business a considerably amount in time as well as tax to account for.

Cash accounts obviously do not agree with GAAP, international or domestic, and certain businesses will find it more complicated to cash account than use the conventional basis, for instance those who keep material levels of stock and have high levels of debtors and creditors.

Consider the following example:

A new business which is cash accounting in its first year, for instance a shop, will find that its purchases may be understated, if it takes 30 days credit, but correspondingly, it will not have made an adjustment for its closing stock either and so this may contra out the difference to a greater extent. A shop will not normally have any major debtors, but even if it did, no business can survive without cash so it would be very unlikely that it would build up huge levels of debtors just to try and avoid tax. There is no reason why capital allowances should not be given to create a tax deduction for the wearing out over time of fixed assets.

All in all cash accounting seems to have quite a few merits, and so last week, we posed the question to you, our members, "Is cash accounting the solution, or is there another way?"

By coincidence just as this question was being aired, regular contributor Richard Murphy emailed us from Geneva where he was attending the 23rd annual meeting of the UN Intergovernmental Working Group of Experts on International Standards in Accounting and Reporting. While there he happened to attend the session on the future of SME accounting.

The conference heard from the International Accounting Standards Board on its proposed new IFRS on SME accounting. This is likely to in force by 2008/9, and its exposure draft issued shortly. In due course it will replace the FRSSE which dominates reporting by most UK small companies.

Richard suggests that the new standard is going to be "hopelessly inappropriate" for most UK small businesses. The reason is simple, he said. It assumes that the reporting requirements of all companies that are not quoted are the same, whatever their size. The result is a standard that will be over 200 pages long that is not designed for the needs of small businesses.

Basically it seems to be a cut down version of the standards used by larger companies and was created by a team that appears dominated by the Big Four that assume that the normal SME has at least 50 employees. That represents well under 10% of SMEs.

This is not going to help small business cut "the tape". So what do our members think about a return to good old fashioned cash accounting, or should we explore some other avenues?

"There's a lot to be said for it", thought Emily Coltman. "Cash accounting would be much more straightforward and less open to subjective estimates and interpretation than accruals accounting - no prepayments, no accruals, no UITF40 adjustments, no WIP. Businesses would have to be scrupulously careful in recording their receipts and payments, particularly in cash-based businesses."

HMRC would I think concur with Emily's view, and I can see it would make the Revenue's job much easier, they would need less accountancy training too.

Gerard Somers too found the idea "eminently sensible", pointing out that Customs & Excise allow it for VAT and certainly anyone trading below the VAT threshold should use it and many businesses are effectively cash accounts traders anyway.

Andy Todd agreed that many owners of small business understand exactly what is going on with their money but have no idea what their accounts actually mean. Mark Gauden gave an example of a public house "where cash accounting would mean an overstatement of profit in that there'd be no debtors to omit from the accounts but there'd be the typically fortnightly brewery main purchase account creditor omitted from the accounts".

Stock would reduce this imbalance to some extent though.

As Richard Murphy added: "Cash is king for the small business, no cash means no future".

Those in favour of cash accounting tended to broadly agree with Martin Foley who said:

"My suggestion is:

# cash accounting for income tax purposes, perhaps something similar to VAT cash accounting. It would be optional (for several reasons), and have turnover cap (say VAT cash accounting turnover cap, perhaps lower).

# cash accounts do not remotely pretend to show a T&FV of any business' profits, but are easily understood by the smallest business, and are (comparatively!!) easily prepared."

I have to agree, many small businesses would find it beneficial to cash account and their owners have no need of "true and fair" accounts, and no idea of the accounting concepts behind them. I have to add that the type of adjustments needed to make your average small business's cash accounts become GAAP accounts are in most cases going to be fairly minor, with the exception of what may be needed under UITF 40, but that is another reason for supporting cash accounting.

Those who argued against cash accounting, such as Dave Collier and Martin Foley, in part, did so on the basis that a business needs true and fair accounts in order to correctly measure profitability and that a balance sheet is likewise a management requirement, as no business can survive without managing its assets, stock, debtors etc.

Phil Rees thought that "the accounts requirement is not the biggest burden on the small trader. Many of the other rules are more of a problem - stakeholder pensions, having to keep a job open for a new mother, constantly changing health and safety regs, employer's NICs etc".

Doug Scott suggested that cash accounting can give you a "horribly inaccurate" picture.

I agree with the arguments on both sides, but I still cannot see why it should not be possible for the smallest businesses to cash account if that is what they would like to do. I suggest a turnover level that is lower than that for cash accounting for VAT, more like £50 -75,000 p.a.

This would mean that a huge number of the smallest businesses – the self-employed teachers, building and allied trade sub-contractors, driving instructors, cabbies, etc would all be able to sit and do their own accounts without a further thought.

They may need some assistance to claim capital allowances, but as far as their accounts were concerned they need only keep a cash book and reconcile the bank in what ever fashion they chose from day to day. I agree with those who thought that no limited companies should be allowed to cash account.

In conclusion, I think that we have found the solution to Gordon Brown's great quandary on "tax motivated incorporations", a bit late in the day admittedly! If we allow small business to cash account, but only unincorporated businesses, then it follows that many unincorporated businesses who before might have seen incorporation as a good tax saving wheeze will not find it quite so attractive in the future.