In association with
Save content
Have you found this content useful? Use the button above to save it to your profile.
small business owner | accountingweb | Cash basis to replace accruals for self-employed
iStock_xavierarnau_small_business
Brought to you by PracticeWeb

Cash basis to replace accruals for self-employed

by

The Chancellor has announced that cash basis is to replace accruals for the self-employed as standard accounting process for 2024/25 (first year of tax year accounting).

22nd Nov 2023
In association with
Save content
Have you found this content useful? Use the button above to save it to your profile.

Promising to make it “easier for small businesses as they set up and grow” the Chancellor has announced the expansion of the cash basis of accounting to replace the accruals basis for self-employed taxpayers and partnerships from April 2024. This follows a consultation earlier in the year

This is a fundamental change with the potential to create very different profits for a lot of businesses currently using the accruals basis (accounting for income and expenses when earned and incurred). Taxpayers deciding not to opt out of the cash basis will face a complicated transition in 2023/24, on top of the unavoidable basis period reform headache. 

Currently, the default position is for businesses to use the accruals basis of accounting to calculate their taxable profit. Businesses with total receipts below the £150,000 entry threshold are eligible to elect to use the cash basis, although many will opt to use the accruals basis. The new measures look to turn that process on its head, making the cash basis the default position for all self-employed taxpayers and partners, with an option to elect for the accruals basis.

MTD ready

This move has the potential to tackle one of the biggest stumbling blocks to the implementation of Making Tax Digital for income tax self assessment (MTD ITSA) by allowing taxpayers to turn the data they have readily to hand – bank statements – into the required quarterly reports, rather than having to process accruals-based adjustments to make quarterly data and estimates more meaningful. (By the way, the Autumn Statement revealed that the proposed end-of-period statement under MTD ITSA will no longer be required.)

Giles Mooney from PTP Limited said: “This bombshell is the latest confirmation that HMRC has been really struggling to solve the obvious problems inherent in the MTD ITSA programme and has now recognised that the only way it can get it off the ground is with considerable simplifications.”

Open to manipulation

Although undeniably simpler to administrate, the cash basis is arguably easier to manipulate than the accruals basis. A taxpayer wanting to massage their figures to push profits into the next tax period can choose to pay their suppliers early, or ask their customers to hold off on settling their invoice for a week or a month to ensure the income falls into the subsequent tax year. 

Cash accounting

Many of our readers will face the prospect that if several of their clients decide to go with the default and switch to cash accounting, the accruals-based adjustments requiring an agent or bookkeeper will no longer be needed so all those clients will go. “This will bite gradually over a number of years,” said Mooney.

Visit our dedicated Autumn Statement 2023 hub here to find all related articles from our experts. 

PracticeWeb Autumn Statement 2023 Covers

Replies (30)

Please login or register to join the discussion.

avatar
By Calculatorboy
22nd Nov 2023 20:34

It's because the chancellor and hmrc dont understand basic double entry bookkeeping and get confused easily .

Thanks (23)
Replying to Calculatorboy:
Tornado
By Tornado
23rd Nov 2023 00:07

It is increasingly looking that way!

Thanks (7)
Tornado
By Tornado
22nd Nov 2023 22:47

A total disregard for Accounting Standards is the ultimate madness.

Heaven help us all!

Thanks (20)
avatar
By Open all hours
23rd Nov 2023 06:53

So you go to your lender with the best available manipulated figures or you really do need two sets of accounts. The inmates have taken over the asylum.

Thanks (15)
avatar
By Crouchy
23rd Nov 2023 11:31

surely the real reason for this is a higher tax take and nothing more

many will have a boom or bust siutation, yo-yoing between higher rate one year and basic rate the next, all with no real appreciation of how they are actually doing

Thanks (10)
avatar
By FactChecker
23rd Nov 2023 12:47

Akin to tackling the problem with polluted air in cities by dictating a change in the default position of pedestrians to one of 'not breathing'?

Thanks (6)
avatar
By CJaneH
23rd Nov 2023 13:15

Cash acounting to me is not simpler, but simply wrong.
Best example I have of cash accounting being innapropiate is one man band Central Heating Engineer who is trading with a profit close to the personal allowance threshold. It is vital to match the CH boilers purchased with sales invoices for installation and place in same accounting period. Other traders who purchase expensive goods and materials for instalation will have very distorted results id using cash accounting.

Thanks (17)
avatar
By Wanderer
24th Nov 2023 04:52

Per .gov.uk

.gov.uk wrote:
When cash basis might not suit your business
Cash basis probably will not suit you if you:

want to claim interest or bank charges of more than £500 as an expense
run a business that’s more complex, for example you have high levels of stock
need to get finance for your business - a bank could ask to see accounts drawn up using traditional accounting to see what you owe and are due before agreeing a loan
have losses that you want to offset against other taxable income (‘sideways loss relief’)

There is rarely a situation when taxpayers are going to be better off, in terms of total tax paid, by using the cash basis.
Although the 'simplification' is often quoted, in practice there are likely to be large swings in the tax payments for small traders making coping overall more difficult for them.

Thanks (10)
Replying to Wanderer:
avatar
By NotAnAccountant2
24th Nov 2023 08:47

Wanderer wrote:

There is rarely a situation when taxpayers are going to be better off, in terms of total tax paid, by using the cash basis.
Although the 'simplification' is often quoted, in practice there are likely to be large swings in the tax payments for small traders making coping overall more difficult for them.

I'm not disagreeing with you.

I suspect for many small traders actually the "accounting" is something they really don't care about. Their only reason for doing it is to pay their tax and to get a mortgage. What they care about is cashflow. They struggle to understand how they can be short of cash but making a profit.

What accountants need to explain to their small traders is that accruals, however confusing it might seem, makes cashflow much easier as their tax will be related to the jobs they're doing. Business is slow in one year, so they don't make enough to pay any tax, but it picks up in the new year. Many of their expenses for that work fall into the year where their profits were below the personal allowance (or the 40% band) so are wasted while the eventual payments from their clients are taxed in the following year at a higher rate.

When I started letting a property, cash based accounting wasn't an option. When cash based accounting came in I didn't know how to do the adjustments to switch (by this point I didn't have an accountant as almost all of my income was PAYE), so I stuck with accruals. I then researched it - intending to switch eventually - but once I understood what I was doing I realized that, even with the pain of a problem tenant who isn't paying the rent, accruals makes things much simpler. (For MTD, 90%+ of the income and expenses are known for the entire tax year at the point that the lease renews)

Thanks (3)
avatar
By Arcadia
24th Nov 2023 10:45

We will be on a hiding to nothing. Eg, accruals profit £50k pa. Year 1 profit only £40k because a large customer didn't pay until day one of the new accounting year, Year 2 profit £60k, much wailing and gnashing of teeth at the much higher tax bill - accountant's fault.
Recently had someone who had expensive repairs done in a rental property over March/April. Didn't get the bill until after 5 April. Client wants the pre-5 April costs accrued, displaying a sudden acute appreciation of accruals accounting hitherto unsuspected.

Thanks (9)
avatar
By Tom+Cross
24th Nov 2023 12:27

It just confirms what I've though for some time. The current bunch have no ****ing idea. What is the point of being engaged in a profession if you shouldn't employ basic first principles. CJaneH succinctly and accurately provides a perfect example. While we're at it, why not overlook; own consumption, private use adjustment indeed, anything that seems too difficult to comprehend.
I just don't understand why politicians can't stick to what they're good at. Oops, I forgot, they aren't good at anything.

Thanks (17)
avatar
By Calculatorboy
25th Nov 2023 20:56

I wonder if it's possible to get the chancellor & chief executive of hmrc sectioned under the Mental Health act 1983 and sent to hospital for some much needed treatment .

Thanks (4)
avatar
By Ben Alligin
27th Nov 2023 09:34

Pity the poor sole trader exceeding £300k for year ending 30th April 2023. They will have to switch to accrual accounting for that year, create a catch-up charge and amortise that over the next 6 years.

Oh their accounts 30 April 2023 fall in tax year 2023/24, so we now have to change their accounts year end to 31 March/5 April 2024. Great, so now we have some transition profit to spread over 5 years. The 11 month period of account will also be prepared on the accruals basis.

Then in tax year 2024/25, we have to ditch accrual accounting and we are back to the cash basis with an opening aged debt adjustment which reduces their turnover in that set of accounts. So they are now under-reporting their turnover in the 2024/25 tax year on the cash basis, due to this latest rule change.

Oh well that makes life a lot simpler for both the tax payer and HMRC!! As for the mortgage lender trying to comprehend this, they will simply reject the accounts/tax return on the basis that it is too complicated for them to understand it.

Thanks (2)
Morph
By kevinringer
27th Nov 2023 09:34

HMRC have finally woken up to the complexities of MTD ITSA that we have been warning them about since 2015. But so much HMRC capital (money, hopes and dreams) has been put into MTD ITSA, that something called MTD has to happen even if it is vastly different to the MTD that was announced in 2015. HMRC realise that the only way this can happen is when record keeping is dumbed down, as long as HMRC can still call it MTD. HMRC have completely lost sight of why they wanted MTD in the first place and instead have become intoxicated with digitisation of records, at any cost, believing that is what it's all about (forget about accuracy, and meaningful accounts). MTD really is the HS2 of the tax world.

Thanks (7)
avatar
By mikejlee
27th Nov 2023 10:27

Does this mean sideways relief will continue to be unavailable to those using a cash basis?
What about capital expenditure - can this be claimed as a trading deduction instead of claiming capital allowances - not that it makes much difference to the end result?

Thanks (0)
Replying to mikejlee:
Morph
By kevinringer
27th Nov 2023 10:52

https://www.gov.uk/government/publications/expanding-the-income-tax-cash... removes the sideways loss restriction. It also removes the £500 interest restriction. But most cash basis figures I have seen compiled by clients will claim the entire loan repayment, not just the interest because that is too complicated. Given HMRC/Government's current "if it's too complex for MTD we'll get rid of it" policy, maybe they will make total repayments tax deductible too. I would not be surprised, because they have abandoned any standards they previously had.

Thanks (2)
Pile of Stones
By Beach Accountancy
27th Nov 2023 10:52

I'll be putting any new clients on the accruals basis - they aren't interested in accounts in the first place, which is why they employ an accountant...

Thanks (1)
avatar
By chancewind
27th Nov 2023 10:53

How does this take into account stock, is that out the window as well?

Thanks (0)
Replying to chancewind:
Morph
By kevinringer
27th Nov 2023 11:28

Stock is not cash, so is out of the window. https://www.gov.uk/government/publications/how-to-calculate-your-taxable... deals with the transition.

Thanks (0)
avatar
By Andrewmoore777
27th Nov 2023 11:14

The big question is: how will debtors and creditors included in the set of accounts preceding the change in basis be treated on the transition? HMRC's long standing view on a change in basis is that accounts must reflect the opening and closing position on the same accounting basis. If so, those with higher debtors than creditors will lose out and the obverse will also apply.

Thanks (0)
Replying to Andrewmoore777:
Morph
By kevinringer
27th Nov 2023 11:26

There's no mention of how to handle transition in https://www.gov.uk/government/publications/expanding-the-income-tax-cash.... Therefore I assume the normal rules apply https://www.gov.uk/government/publications/how-to-calculate-your-taxable... you adjust in the year of the switch.

Thanks (0)
avatar
By chancewind
27th Nov 2023 11:30

What happens to a pool of assets on which no capital allowances have been claimed in the change over to cash accounting. There are many clients i will keep on the old accrual basis as I only claim capital allowances sufficient to reduce to personal allowances presumably that will still be allowed!

Thanks (1)
Replying to chancewind:
Morph
By kevinringer
27th Nov 2023 12:25

Something else answered in https://www.gov.uk/government/publications/how-to-calculate-your-taxable...

"If you paid in full for items of equipment (but not cars), and you had a balance of capital allowances (read capital allowances and balancing charges below) still to claim on that equipment, at the end of your accounting period last year.

Add the balance of capital allowances you can still claim to your total cash basis expenses for this accounting period."

Thanks (1)
avatar
By agknight
27th Nov 2023 12:07

Dodge City awaits, where we advise clients to postpone or speed up receipts or payments according to their tax year.
Without the matching concept this will render accounts review useless. So they will be unable to compare margins etc year on year and decide to investigate anything wayward.

Thanks (2)
avatar
By Ian McTernan CTA
27th Nov 2023 15:54

The lunatics have finally taken over...this is madness.

Now we will have to warn clients that getting paid/paying just before 31 March could be bad for their wealth!
'How can I save tax this year'? says the client. Easy, buy all the materials this year for that job starting in April, or get paid by a client after 6 April and defer tax by a year. Isn't cash accounting wonderful....

It's time HMRC just give up. But too much mud on faces if they did so it's not going to happen.

Thanks (1)
avatar
By gillsoffice
28th Nov 2023 18:54

As previous comments have stated - this is just plain wrong. It goes against the main principles we learnt from the start and have applied throughout our careers and are accepted world wide. Although clients may struggle with the term 'accruals' I think they would all agree that profit represents the sales income less the associated cost of that sale and that is what they expect their accounts to show.
The Govt/HMRC seem to think that all smaller businesses run on an even sales level, with no highs and lows, and that expenditure is incurred in the same way. Practically all of my client base are small businesses and none of them have this pattern of income and expenditure.
I really hope that our institutes are lobbying the Govt advising them how reckless this is and how it makes a mockery of our profession.

Thanks (0)
Replying to gillsoffice:
Morph
By kevinringer
28th Nov 2023 19:52

We need to lobby our professional bodies to ensure they understand the strength of feeling.

Thanks (0)
avatar
By steve 12321
01st Dec 2023 10:59

This is just more non-sense to get MTD for ITSA to "work". They just haven't got a clue! They have no interest in helping businesses, they think they do, whilst ignoring those who have valid points to make regarding this! Which is to scrap it asap!

Thanks (0)
avatar
By HLB
02nd Dec 2023 08:18

So it’s easier to prepare quarterly accounts from bank feeds. What about CASH. From a good review of a traders figures prepared on an accruals basis you can usually spot if income (or something else) is missing and can ask the client. Not much chance of that on a cash basis. I thought MTD was going to increase the tax take by making records more accurate? I’m so glad I’ve retired.

Thanks (0)
By cfield
04th Jan 2024 18:43

The simple answer to this latest piece of nonsense is just to ignore it, tick the box to opt out and carry on using accruals. Don't waste your breath arguing with idiots.

According to the Consultation document, it sounds as though that's what people have been doing anyway. One passage reads "However, more than two-thirds of eligible businesses, around 3 million self-employed people, do not currently use the cash basis even though the government thinks that many could benefit from its simplicity."

I wonder why! Could it be that the average business person knows in their bones that stock is not an expense until it is sold, that debtors are income (assuming they pay up) and creditors are expenses. Unsurprisingly, they want to know what their true profit is, but they don't want to keep 2 sets of books just to please the taxman. Could that be why take-up is so low?

Of course, you wouldn't expect a politician or bureaucrat to understand all this as most of them have never run a business in their lives and have no concept of profit.

Given that 2/3rds of businesses have eschewed cash accounting, it is perplexing to then read the words "The cash basis is an example of a successful tax simplification which has made the tax affairs of many small businesses more straightforward...". By what measure is it a success if most eligible businesses have ignored it?

They attribute the low take-up to "specific restrictions and limits imposed when the regime was originally introduced" and wonder if they should relax them. Well yes Einstein, it might make a difference if interest was not restricted to £500 and loss relief was allowed, but those are not the main reasons for this being anything but a successful tax simplification.

The main reasons are that most businesses small enough to qualify but large enough to have stock, debtors and creditors already have an accounting system with an accountant to run it, and see no reason to switch to cash (other than for VAT) for the reasons given above. Usually the accountant will decide, as the client will simply be bemused by the proposed change and leave it up to him/her.

Ironically, the businesses most likely to benefit (in the Government's eyes) are the very same ones that should not switch to cash-accounting because they need to know what their true profit is. The smaller firms would benefit from not having to do accruals/prepayments, but these are usually so low as not to make much difference to profit anyway, and the ones without accountants don't even bother, so all the Government has done is legitimise their accounts, assuming they restricted their interest paid figures, which they probably didn't.

So how does this affect MTD? Well, for me, it's all about humouring HMRC but keeping the cost of their quarterly submissions as low as possible. Best way is just to take the totals of the debit/credit
columns on their bank statements and put them through. That should take say 15 minutes per quarter. Then, do the accounts properly at the end of the tax year, work out the differences to the quarterly submissions, do the EOPS and that's it, job done. The client knows what his true profit is and has a sensible tax bill that won't go up and down like a yoyo each year. The mortgage lenders have accounts they can rely on. HMRC get their quarterly submissions and can pat themselves on the back that MTD is working.

Everyone's happy, sort of. Of course, it won't affect the tax gap, which has now fallen dramatically from 7.5% in 2005/6 to 4.8% in 2021/22 even without MTD, if we can trust those figures, but they have probably forgotten all about that as the main driver anyway. The main driver now is simply the project itself and getting it completed with as little fuss and delay as possible. They will probably come up with something to prove it was worth it. I don't suppose any lessons will be learnt. They never are!

Thanks (1)