Cash vs accrual bookkeeping and VAT

Statutory accounts vs tax choices

For limited companies, statutory accounts filed at Companies House are prepared on an accruals basis. Even if you use “cash-like” reports for internal management, the year-end accounts your accountant files will still be accrual-based.

Self-employed businesses and partnerships may be able to choose between cash and accruals for their income tax returns. It is increasingly common for the cash basis to be the default for smaller businesses, but you can opt out if accruals gives a clearer picture.

Sales invoices and credit notes

On an accruals basis, income is recognised when you raise a sales invoice; on cash basis, it is when the customer pays. Credit notes follow the same rule as the original invoice.

• If you invoice a client on 28 March and they pay on 10 May, an accruals approach treats it as March income; cash basis treats it as May income.
• If you later issue a credit note, it should be dated when the reduction is agreed, so the reversal lands in the correct period and VAT return.
• For landlords, this principle applies to rent schedules and rent holidays as well as commercial invoices.

Supplier bills and regular costs

Bills for rent, software, insurance and utilities often relate to a period that spans several weeks or months.

• On an accruals basis, costs are matched to the period they relate to, even if you pay earlier or later.
• On cash basis, the cost appears when you actually pay it.
• For bigger items such as equipment, accruals accounting may spread the cost over several years through depreciation, while cash basis might allow a full deduction in the year of payment (subject to HMRC rules).

Deposits, retainers and staged work

Many contractors, CIS workers and locums take deposits or invoice in stages. The timing method determines when that income is recognised.

• Deposits can be treated as income when received (cash basis) or when work is performed (accruals). For larger projects, accruals helps avoid one quarter looking artificially high.
• Retentions in construction often remain unpaid until a project is signed off. Accruals accounting may still recognise part of the income once work is complete, even though the cash is delayed.
• For landlords taking advance rent, it is important not to double count income when a rent free period or deposit is involved.

Standard VAT (invoice basis)

On the standard scheme, output VAT is due when you raise a VAT invoice or receive payment, whichever comes first. Input VAT is reclaimed when you receive a valid VAT invoice from a supplier.

• This lines up neatly with accruals bookkeeping and with most accounting software default settings.
• It can, however, be harsh on cashflow if customers pay late but VAT is still due to HMRC based on the invoice date.
• Credit notes reduce your VAT liability in the period they are dated, so late credit notes can shift VAT between quarters.

VAT cash accounting scheme

Under the VAT cash accounting scheme, you pay VAT to HMRC only when customers pay you, and reclaim VAT only when you have paid suppliers. This can help where you have long payment terms or slow paying customers.

• The scheme is usually available up to a specified turnover threshold and must be monitored as your business grows.
• It often suits service businesses, CIS subcontractors and locums who invoice large values but may wait weeks for payment.
• If you regularly reclaim more VAT than you pay (for example, because of heavy capital expenditure), cash accounting may be less attractive as it delays recovery.

Flat rate VAT and timing

Some small businesses use the flat rate VAT scheme instead of standard or cash accounting. Here you pay a fixed percentage of your gross takings to HMRC and usually do not reclaim VAT on individual purchases (with limited exceptions).

Although the calculation is different, accurate timing still matters. You must include all relevant takings in the correct VAT period, and keep records that clearly show when income was received.

Limited companies

Company accounts are prepared on an accruals basis even if day-to-day reporting is more cash focused. That means:

• Sales and costs are matched to the period they relate to, not just when paid.
• Year-end adjustments bring in unpaid invoices, prepayments and accruals.
• Directors need to be aware that company profit for the CT600 may differ from the bank balance, especially if customers pay slowly.
• A company can still use the VAT cash accounting scheme for cashflow purposes, while the statutory accounts remain accrual-based.

Self-employed and partnerships

For income tax, many smaller unincorporated businesses are able to choose between cash and accruals.

• Cash basis can make record keeping simpler and align tax with money in the bank, which some traders prefer.
• Accruals can give a clearer picture where there are large unpaid invoices, stock, work in progress or complex contracts.
• Lenders and mortgage providers often expect accounts that look more like an accruals basis, even if your tax return uses cash basis.

Landlords

For landlords, timing decisions cover more than just monthly rent.

• Repairs, service charges and management fees often relate to specific periods and may need to be apportioned.
• Deposits and rent in advance must be handled carefully so that income is not overstated when a tenancy starts.
• Where properties are held in a limited company, the company will follow accruals rules in its accounts even if individual payments feel “cash like”.

CIS workers, contractors and locums

Construction Industry Scheme (CIS) and locum work often involves irregular payments, retentions and tax deductions.

• CIS subcontractors have tax stopped at source on payments received; record keeping needs to match CIS statements so that deductions are correctly reported.
• Contractors and agencies need clear cut-off between work done before year-end and work done afterwards, particularly where large invoices are raised around the same time.
• Locums with multiple agencies benefit from consistent timing rules so their accounts and self assessment are easier to understand.