Money Matters

Cash basis changes: How accountants can support their clients

Are your small business clients ready to take advantage of upcoming cash basis changes? Learn how to prepare your clients for these changes.

The UK government ran a consultation during 2023 on the cash basis rules as part of its wider focus to simplify tax for small businesses.

Right now, more than 66% of eligible businesses don’t officially use the cash basis, even though the government believes many may benefit from its simplicity.

In reality, the number of taxpayers using the cash method is probably much higher than what is reported because of the number who do not realise they need to opt out of the default accrual basis.

So the result of simplifying and expanding the cash method should create a more accurate picture of cash basis use across UK unincorporated businesses.

In this article, we break down what changes will be implemented, which clients are affected and how you can help your clients with these changes.

Here’s what we cover:

What is changing with cash accounting?

There are four main changes that have come about from the results of the consultation.

  1. Cash basis will become the default method for calculating taxable profits. The default is currently the accrual method, but after the changes come into effect, businesses will need to opt out to continue using accrual accounting.
  2. The turnover thresholds for businesses to use cash basis will be completely removed. The current limits for businesses mean their turnover must be below £150,000 to join the cash basis. And once they reach £300,000, they must stop using it and move to the accrual basis.
  3. The current £500 limit on interest deductions when using cash basis will also be removed. This will align the rules with the accrual basis.
  4. The current restrictions on using relief for losses made under cash basis will be removed too, again aligning the rules with the accrual basis.

When will the cash basis rules change?

The expansion of cash basis accounting will come into force from 6 April 2024.

Businesses affected by the changes

These changes will affect all unincorporated businesses, as in individuals who are self-employed (sole traders) or control a partnership.

Going forward, these businesses will have the option to prepare accounts under the cash basis regardless of their turnover.

Should your clients use cash basis or accrual accounting?

As an accountant, it’s most likely you are already using the accrual accounting method to prepare your client accounts and won’t find any advantage in switching to the cash basis.

There are several reasons why accountants shouldn’t recommend cash basis to their clients solely because they are now eligible under the new rules:

  1. If you prepare monthly management accounts for your client to track their business performance and debtor/creditor positions, switching to cash basis would make this impossible.
  2. If your client’s business sells inventory, accrual basis accounting is required to align revenue with the related expenses, so you and your client are able to track profit margins on inventory and see an accurate picture of financial performance over specific periods.
  3. Third parties such as banks often require a set of accounts prepared under UK GAAP to approve credits and loans. Using the cash basis essentially leaves your client without a balance sheet, so they can’t demonstrate their strength to borrow money.

There are certain situations where it is beneficial for business owners to use cash basis, for example, barristers and solicitors who are paid by the legal aid system and can potentially wait years after raising an invoice before receiving payment.

Under accrual accounting, they would be disadvantaged by paying tax on income long before they receive it.

But in general, accountants are doubtful that removing the turnover limit on cash basis reporting will encourage more businesses to take up the cash basis because ultimately they need the information provided by accrual accounting to make informed business decisions.

It’s more likely that the rule changes will help those taxpayers without an accountant to accurately report their cash basis accounts.

Most individuals preparing their own accounts are using the cash basis because they don’t know there is another way, so whether they are reflecting it accurately or not they will use it.

How to help your clients with cash basis changes

For clients who are currently using the accrual basis and will continue to do so, the only change required when preparing their tax return is to tick the box to opt out of the default cash basis.

For existing cash basis clients, no changes are required. In fact, digital record keeping will make income tax return preparation even easier under Making Tax Digital because the quarterly reports are driven by a bank feed.

For any clients switching their reporting basis, whether from cash basis to accrual accounting or vice versa, you’ll need to guide them through the adjustments required in the first transition year to ensure all income and expenses are accounted for correctly.

For example, receipts in the first cash basis year might include amounts received from customer debtors at the end of the previous tax year.

If your client sends an invoice on 30 March 2024, and it’s unpaid at year-end, under the accrual method they have already recognised that income.

When the cash appears in the bank account the following tax year under cash basis, it will need to be deducted from these accounts otherwise the income will be counted twice.

Similarly, payments made to the client’s suppliers in the cash basis period might include settlement of amounts owed for purchases made in the previous tax year.

So when the payments are made out of the bank account in the following tax year under cash basis, they’ll need to be excluded, otherwise the expenses will be counted twice.

Other transitional adjustments could be required if:

  • Your client had debts owed to them by customers at the end of the previous tax year
  • Your client held trading stock at the end of the previous tax year
  • Your client had claimed capital allowances on equipment purchases, and there were allowances still to be claimed at the end of the last tax year
  • Your client is VAT registered and prepared their last tax return using VAT inclusive sales and purchases figures
  • Your client used equipment under a finance lease
  • Your client’s business profits in the previous tax year included other non-cash items such as accrued expenses, prepayments, or income received in advance.

You can read more about these transitional adjustments in HMRC’s Business Income Manual.

Final thoughts on the cash basis changes

In most cases, it will be a simple decision to continue preparing client accounts under the accrual accounting basis, either due to the complexity of the client’s business or because of third party reporting requirements.

If a client decides they want to switch to the cash basis to take advantage of its simplicity, it’s important they first understand both the advantages and disadvantages.

This is where your valuable advice will guide them in making the best decision.