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FINANCIAL LITERACY •  16 OCTOBER 2022 • 4 MIN READ

The difference between accrual and cash accounting

The difference between accrual and cash accounting

You may have heard about financial statements being prepared on either an accrual basis or on a cash basis and wondered about the difference between the two. Well, wonder no more!​

Cash basis

When prepared on a cash basis, financial statements include only transactions which went through the business bank account. If you paid some business costs personally, we include those as well.​

Income is recognised only when money is received and costs are only recorded when physically paid.​

The cash basis can only be used by sole traders and partnerships with annual turnover of less than £150,000 a year.

Accrual basis

An accruals set of financial statements is different. It is based on transactions that took place during the year – whether they were in cash or not. Most accounting systems default to the accruals method of preparing financial statements.​

Almost all of the financial statements we prepare use the accruals basis. This is not only to meet HMRC requirements, but it’s also a better reflection of business operations – all income and expense transactions during the period are accounted for. You can’t make your business look better (using a cash basis) by just not paying your bills!​

Below are some examples of non-cash transactions.​

Accounts receivable

If you made a sale on 30 March 2022 and sent out an invoice, it’s unlikely you’ll receive the money before year-end (assuming your year end is 31 March 2022). As the sale itself took place in the 2021/22 year, we need to account for this income. We therefore record the sale as taxable income and the outstanding amount is shown as an accounts receivable asset (also called debtors) in the balance sheet.​

Accounts payable

Invoices you receive from suppliers before 31 March 2022, but haven’t yet paid, are another example of a transaction taking place in the 2021/22 tax year. Financial statements prepared on a cash basis won’t include that as a cost until the invoice has been paid. Accrual accounting however, does include that cost, whether as an asset purchased or a business expense. As the invoice hadn’t been paid by 31 March 2022, the business has a liability in its balance sheet.​

Depreciation

Most assets depreciate (lose value) each year. Think of a motor vehicle – as soon as you drive it off the forecourt, you’re unlikely to sell it for more than it was purchased. The decrease in value doesn’t involve cash, but needs to be accounted for in accrual financial statements. 

Accrual accounting factors in the depreciation concept and each year, we can claim depreciation as an expense. Financial statements prepared on a cash basis will not show this decrease in value. The asset will continue to be shown at its original cost.​

Gains or losses when selling an asset

Depreciation is an accountancy concept, and those rates may not reflect the exact reduction in asset value each year.​

When you sell the asset you’ll receive cash. This isn’t income. Instead, we sell the asset from the asset register.  If you have received less than the asset’s book value*, the business will have a loss. If you receive more than the asset’s book value, you’ve claimed too much depreciation in the past.​

Cash accounting will only show the sale price (money coming in).​

* The book value is the original cost less all depreciation claimed from the time the asset was purchased​.

Charlotte

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Profit and loss account on a cash basis

Accounting systems will often have the option of running the profit and loss account on a cash or accrual basis.​

If you use Xero, we’ve included the relevant steps below needed to generate your profit and loss account on a cash basis. These steps come from Xero’s instructions on how to prepare a profit and loss account.​

  1. In the Accounting menu, select Reports.
  2. Under Financial, click Profit and Loss (New).
  3. Set Date Range.
  4. Click the settings icon for additional options.
  5. Select an Accounting basis, either Accrual or Cash
  6. Click Update.
  7. Just note that the report will always default back to Accrual. You’ll need to select Cash next time you’d like to see the report.​

…you can also take a look at Xero’s Cash Summary report. It shows a summary of all cash transactions, not just those affecting profit.​

When preparing financial statements used to complete tax returns, we’ll always use the accrual form of accounting as this is what is required by law. 

Who are Beany? 

We’re an online accounting firm that is always right here for you, your accounting pain relief. The most advanced technology lets us work way more closely with you than a normal accountant would. ​

We have a dedicated team of certified accountants and a support team to take care of your business no matter where you are, so you can focus on growing your business. We take out the ‘fluff’, break down the barriers and get things done. Looking out for you is what we are all about. Get started for free today.

Charlotte

Charlotte Wass

General Manager, Beany UK

Chartered Accountant and Chartered Tax Adviser based in London. I love autumn, otters and Malteasers, and I hate spiders, peanut butter and the London Underground.

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