Money Matters

Cash basis changes in 2024: What they mean for businesses

Discover how cash basis rules have changed, what that means for your business with regards to your accounting, and what to do about it now.

During 2023, the UK government ran a consultation on the current income tax cash basis rules to find out how they could be simplified and expanded.

Prior to the new tax year, which started in April 2024, more than two-thirds of eligible businesses didn’t officially use the cash method and many could benefit from it.

So this is an opportunity for the government to simplify tax for small businesses along with Making Tax Digital.

The new rule changes are designed to remove the complexity of using cash basis.

If you’re a small business owner wondering how these changes affect you, this article will inform you about the two methods of accounting (cash basis and accrual), and what you need to do, if anything, to comply with the changes going forward.

Here’s what we cover:

What has changed with cash basis accounting?

There are four key changes that have come about from the findings of this consultation.

They affect all unincorporated businesses in the UK, i.e, individuals who are self-employed or a partner in a partnership.

  1. The cash basis is the default method of calculating taxable profits. The default was the accrual method, but now the changes are in force, businesses need to opt out of the default on their tax return to continue using the accrual method.
  2. The turnover thresholds for businesses to use the cash basis have been removed entirely. Previously, turnover needed to be below £150,000 to join the cash basis and once a business reaches £300,000 turnover, it needed to move to the accrual basis.
  3. The previous £500 limit on interest deductions when using cash basis has also been removed. There are no limits under accrual accounting, so this will align the two methods.
  4. The previous restrictions on using relief for losses made under cash basis have been removed. This also align it with the rules under accrual accounting.

When did the changes come into force?

These changes came into force on 6 April 2024, the beginning of the 2024/25 tax year.

This means they’re applicable when you file your Self Assessment tax return ahead of 31 January 2025.

Cash basis vs accrual accounting

Cash basis and accrual accounting are two different methods used to record financial transactions in accounting.

They differ in when they recognise revenue and expenses.

Choosing between the two depends on factors such as the size of the business and the need for a more in-depth understanding of financial performance.

Cash basis

Under cash basis, you record transactions only when there’s an actual inflow or outflow of cash. This means revenue is recorded at the time of cash receipt, and expenses are recorded when they are paid.

This method is straightforward and was developed for small business owners with simple transactions, such as web designers, taxi drivers and consultants.

One of the disadvantages of cash basis is it doesn’t adhere to these standards, and you may be required to prepare accounts under these accounting standards for another purpose.

For example, when asking a bank for a loan, they generally want to see a full set of UK Generally Accepted Accounting Principles (GAAP) accounts with a balance sheet to demonstrate the strength of the business to borrow money.

Accrual accounting

Accruals accounting, on the other hand, recognises transactions when they are incurred or earned, regardless of when the cash is received or paid.

This means you usually record income at the time you invoice the customer, rather than when you receive payment for the invoice (which could potentially be months later).

Accrual accounting is beneficial because it provides a more accurate picture of financial performance and position.

The accounts more accurately show when income and expenses actually occurred each month as well as the debtor and creditor positions at the end of the period.

It’s beneficial to use this method when selling inventory to align revenues with their related expenses – the cost of goods sold are recorded at the same time as the revenue from the goods.

The downside to accrual accounting is it requires more complex bookkeeping, and it involves estimates and adjustments for items such accruals, prepayments and depreciation.

Accrual accounting is generally required in order to comply with accounting standards such as UK GAAP and International Financial Reporting Standards (IFRS), making it suitable for more complex businesses that must adhere to these standards when preparing financial statements.

What businesses should do now and who can support them

If you’re self-employed (a sole trader) or you are a partner in a partnership, from the 2024/25 tax year onwards, cash basis has become the default method of preparing taxable profits on your tax returns.

But that doesn’t mean you’re required to adopt cash basis if you’re currently preparing accrual accounts.

You should always ask an expert, such as an accountant or tax adviser, before you take any action to change your accounting method as it may have unforeseen consequences.

An accountant will be able to run you through the pros and cons of cash basis versus accrual accounting and inform you which one is more appropriate for your business.

If you discuss the best option with your accountant, and decide to continue using accrual accounting, the only change required when filing your tax return will be to select the option to opt out of the default cash basis.

On the flip side, it might be that you’ve already unknowingly been preparing your tax return under cash basis and perhaps haven’t been ticking the ‘cash basis’ box on the return.

If this is the case, again, you won’t need to do anything differently going forward.

If you and your accountant decide it’s beneficial to switch from accrual accounting to cash basis, there will be some income and expense adjustments required in the first year to ensure you account for all income and expenses correctly.

For example, payments made to your suppliers in the cash basis period might include settlement of amounts owed for purchases already accounted for in the previous tax year.

So these payments will need to be deducted from the cash basis accounts otherwise the expenses will be counted twice.

Your accountant will be able to help you with these adjustments, and give you advice on how to manage your accounts and bookkeeping under cash basis.

Final thoughts on cash basis changes

It’s important to understand there are advantages and disadvantages when it comes to using cash basis.

And even though it’s the simpler method for filing your tax returns, that doesn’t necessarily mean it’s the best option for your business.

So before making a decision to change your accounting method, it’s important to chat to a qualified accountant first.

They’ll be able to advise you on the best way forward based on the complexity of your business and whether you need to prepare UK GAAP complying accounts for any other reason.

Editor’s note: This article was first published in January 2024 and has been updated for relevance.