Last Updated on August 1, 2021 by admin
Cash basis was introduced to make it easier for the self employed to manage their accounts and work out their income and expenses for the year. Cash basis does not mean that you only deal in cash – it is about when transactions are recognised and recorded. This post explains how cash basis differs from traditional or accruals based accounting.
Accruals Basis
When using traditional or accruals basis accounting income & expenses are recognised & accounted for when earned or incurred regardless of whether any money has yet been received or paid.
What does this mean?
This means that income and expenses must be matched to the period they relate to & to ensure this end of year adjustments are necessary. Any prepaid income or expenses must be removed from the accounts prior to finalising them. Any accrued (built up) income or expenses must be added. Only stock actually consumed during the year must be reflected as an expense so this figure must be calculated. Depreciation & carrying amounts for fixed assets such as vehicles & computers must be calculated because the expense must be spread out over the useful life of the asset. Adjustments may also be needed for invoices which were never paid & have become bad debts. It also means that you may have to pay tax on money earned but not yet received.
Cash Basis
With cash basis accounting transactions are only recognised & recorded when payment is actually received or payment is actually made.
What does this mean?
It means that you don’t have to worry about making complicated adjustments in order to calculate your profit. It also means that you will not be taxed on money not yet received.
Cash basis though is not available to everyone and there may also be reasons why it is not suitable for your business – more on that in the next post.