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What are the Pros and Cons of Cash Accounting?

Advantages and Disadvantages of Cash Accounting

By cruse burkePublished 2 years ago 4 min read
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Clients can be given ACCA UK's Guide To... Accounting Using the Simplified Cash Accounting Regime to help them understand this in greater depth.

Clients will learn about the cash basis from a variety of sources, and practitioners must consider whether cash accounting is the best approach for their business.

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Pros

Those who favour simplified cash accounting argue that:

  1. Accounts would be easier to prepare because businesses would not have to make year-end accounting adjustments. They will disregard the standard adjustments for debtors, creditors, and stock.
  2. When a company switches from accrual to cash accounting, the tax due date is likely to be delayed because debtors and work in progress are excluded from taxable income. Deferral may also occur in the first year of change if the trader purchases (and pays for) a large amount of stock near the end of the fiscal year. This is especially important for a trader approaching the upper band threshold.
  3. Business owners will not have to pay tax on income they have not yet received at the end of the fiscal year. In theory, this should make cashflow easier.
  4. Interest on cash advances will be allowed up to £500. It would not be necessary to establish that the borrowing is used to finance business capital because it is not required that the loan be used 'wholly and exclusively' for business purposes.
  5. There is no need to make adjustments for capital allowances for plant and machinery because capital expenditure (other than cars) will simply be relieved as it is incurred, just like any other revenue expense.
  6. The scheme is adaptable because taxpayers can switch from cash to accrual basis if their commercial circumstances change.
  7. Under the cash basis, negative results (losses) can be carried forward and offset against future profits from the same trade.

Cons

Those who oppose the simplified cash accounting treatment, on the other hand, argue that:

  1. The amount of time spent on account preparation will not be significantly reduced due to the fact that the amount of time saved by not computing debtors, creditors, and stock is likely to be minimal. It is likely that a small business will have very good credit-control procedures in place in order to maintain its financial viability. As a result, the size of the business's debtors and creditors will likely be on the smaller side, and the amount of stock, debtors, and creditors will likely be easily accessible.
  2. Cash accounting is good at tracking cashflow but poor at matching revenues earned with money set aside for expenses. Simple cash accounts do not provide an accurate picture of business performance. Banks may require GAAP-compliant accounts in order to provide credit and loans.
  3. Cash accounting may not appeal to new businesses with large capital requirements because the interest on borrowing may exceed the £500 limit on the amount of allowable interest.
  4. If a company chooses not to use the simplified expenses mileage rate, capital allowance adjustments may still be required under cash accounting.
  5. Cash accounting does not allow for a choice in the amount of capital allowances claimed, which may be disadvantageous to a taxpayer who earns a small profit that is covered by their personal allowance. Such a trader is likely to prefer the option of being able to choose the amount of capital allowances claimed in any given year, so that the deduction can be used in a more profitable later tax year.
  6. The increase in the annual investment allowance from £25,000 to £250,000 on 1 January 2013 means that capital expenditure is now covered by the annual investment allowance, allowing for full relief in the year of expenditure in most cases (see also ACCA UK's Guide To... Annual Investment Allowance).
  7. Cash accounting does not completely eliminate the concept of accruals because rental payments for capital items (excluding car and motorcycle hire) are limited to amounts paid in respect of rent.
  8. A capital asset that is used for both business and private purposes must also be adjusted if the proportions of use change. The decrease in business use is accounted for as a sale of a portion of the asset at current market value. This calculation has the potential to cause confusion and errors.
  9. Under cash accounting, sideways loss relief in the year and carry back (including opening year loss relief) will not be available; this is a significant disadvantage for taxpayers with other sources of income (such as employment income) who can use trading losses to reduce their tax bill.
  10. The ability to switch between cash and accrual accounting each year complicates the system, increases the administrative burden, and increases the risk of error.
  11. The tax deferral is only temporary, as the timing differences between debtors, stock, and creditors will be resolved in the future. Transitional rules are in place to ensure that income and expenses are only allowed once.

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