Expanding the cash accounting basis to all self-employed businesses

As part of his 2023 Autumn Statement , the Chancellor announced that the cash basis will replace the accruals basis as the default method for preparing accounts for all unincorporated businesses from 6 April 2024. The announcement means expanding the cash accounting basis to all self-employed businesses.

This will apply to sole traders as well as partnerships. However, Limited Liability Partnerships as well as Companies are excluded. Businesses that claim farmers’ or artists’ averaging are also excluded.

What is the current position?

The default accounting basis for businesses is accruals, but you can opt for a cash basis by notifying HM Revenue & Customs (HMRC) through your self-assessment tax return.

In the future, a business wishing to use the accruals basis will need to opt to do so. What this means is you will be expected to use the cash basis unless you make an election otherwise.

The cash basis is currently only available to businesses with an annual turnover of less than £150,000. Going forward this threshold will now be removed.

What is the cash basis?

Under the cash basis, accounts are prepared based on money received and paid out during the year. The monies owed to the business (debtors) and monies owed by the business (creditors) at the year-end date are simply ignored.

In addition:

· no account will be taken of stock or work in progress.

· businesses will no longer claim capital allowances on assets purchased.

· you can therefore claim the full cost of the asset (adjusted for any personal use) as an expense in the year of purchase.

· proceeds from the sale of an asset will be treated as income in the year of disposal.

It’s important to note that previous cash accounting restrictions, such as loss relief and loan interest, have now been removed. This will make it easier for many of you to adopt cash accounting.

The restriction on loss relief under cash accounting has been removed, allowing for sideways and carry-back relief.

The previous restriction of £500 for the maximum interest that could be claimed as an expense under cash accounting has been eliminated. This means that companies using cash accounting can deduct any amount of interest provided it is wholly and exclusively for the purpose of the business.

Why is there a change from accruals to a cash basis?

This change is part of the move to Making Tax Digital (MTD) which will be introduced from 5 April 2026 for sole traders and landlords.

Under MTD, taxpayers are required to submit quarterly reports to HMRC. Cash accounting allows taxpayers to use readily available data, such as bank statements, to generate these reports.

Although cash-based accounting will be the default option, is it truly a win-win situation for all involved?

Advantages of cash accounting

The business only pays tax on income when it is received, effectively receiving automatic relief for bad debts. If a customer has not paid you, you don’t need to include the transaction in the accounts.

You will be asked to complete simplified accounts that only show your income and expenses.

However, it is important to note that this is not a proper set of accounts. Although it may save you time, not knowing your trading position can be risky, particularly if your business is not small or relatively simple.

Drawbacks of cash accounting

A complete set of accounts will provide you with a clear picture of your profitability and margins. It will show you how much cash you have, as well as the money you are owed and owe.

All of this information is essential to guarantee that your business is progressing in the direction you want.

You get a more accurate picture of the performance and health of your business by using an accruals basis when preparing accounts. This is why many lenders including your bank and other financial institutions would always prefer a proper set of accounts.

What’s more, cash accounting may result in significant profit variations from year to year, particularly due to large capital expenditures. However, full capital expenses allowance has reduced this issue in recent times.

Transitioning from accruals to cash basis

If you decide to transition from accrual to cash accounting in 2024-25 then an adjustment will need to be made in the 2024-25 accounts for balance sheet items at 5 April 2024. The following areas will need your attention:

· Debtors (including prepayments)

· Creditors (including accruals and income received in advance)

· Stock and Work in Progress

· Unclaimed capital allowances

Please note that your accounts and tax returns for the year 2024-2025 will be impacted by certain adjustments. For instance, if the adjustments increase your profits in the said year, it will be shown as income in your accounts. Conversely, if the adjustments lead to a decrease in profits, it will be shown as an expense.

An income adjustment in 2024-25 will not be liable for Class 4 National Insurance contributions whereas an expense adjustment will be deductible when calculating the Class 4 National Insurance liability.

Just remember that this adjustment is a one-time event. It will take into account what will have occurred at a future date.

What should you do next?

The introduction of cash accounting is intended to simplify the accounting process for small businesses. The government has suggested that many businesses out there are using cash accounting without officially electing to do so.

However, before you decide you need to talk to your accountant. If you are working with us please email Martin at martin.wackett@myersclark.co.uk who would be happy to discuss your options with you.

If you are not yet working with us please look at we can help you with your tax