Accounts: accruals basis

Example – accruals accounting

Michelle is self-employed and has a furniture shop.  She has an accounting year end of 31 March. When preparing her accounts for the year ended 31 March 2025 under accruals basis principles she needs to note the following:

• Michelle invoiced a customer on 31 March 2025, so this invoice should be included as sales income, whether the customer has paid it or not. If the customer has not paid on 31 March 2025 the amount should be included as a debtor.
• Michelle paid her annual insurance bill on 1 October 2024 to cover the period from 1 October2024 to 30 September2025, so she only includes half of the cost in the accounts to 31 March 2025 even though she has paid the full amount; the other half would be included in the accounts for the following year as a prepayment.
• Michelle bought nine beds to sell and on 31 March 2025 there are three beds left, so only six beds should be treated as a purchase during the year, with the remaining three beds being treated as a stock asset for the following year (see Business expenses allowable for tax under the heading Costs of goods bought for resale or goods used).

Example-moving from accruals basis to cash basis of accounting

Brian has a garden furniture business and has prepared his accounts to 31 March each year using the accruals basis up to and including his accounts for the year to 31 March 2024. Points to note regarding Brian’s accounts for the year ended 31 March 2024, the details from which were included on his 2023/24 tax return:

1. At the end of the accounting period Brian had sales income of £20,000 which included £1,000 that had not been paid, so his accounts show his turnover (sales) as £20,000 and records debtors of £1,000. In June 2024 he received the payment of £1,000.
2. Brian purchased tools to use in his business in March 2024 and the cost of £300 is included as an expense in his accounts. Brian paid £300 for the tools in May 2024.
3. At the end of the accounting period Brian had closing stock of four chairs which he paid £200 for in February 2024. This closing stock is treated as an asset in his accounts to 31 March 2024 (and not an expense).
4. Brian had a written down value in his plant and machinery general pool of £1,500 at 31 March 2024.

For the 2024/25 tax year, Brian decides to prepare his accounts for the year ended 31 March 2025 using the cash basis. The effect of this on the above is as follows:

1. Under the cash basis, Brian would usually account for the £1,000 received in June 2024 when he received it, but as Brian is moving from using the accruals basis to the cash basis this would result in £1,000 being taxed twice, both in 2023/24 and 2024/25. Therefore, there is a transitional adjustment to the cash basis income in 2024/25 to reduce sales income by £1,000.
2. When Brian is using the cash basis, he should account for all expenses when he actually pays for them and as he paid for the tools in May 2024 this would usually be treated as an expense in his accounts for the year ended 31 March 2025. However, Brian has already received tax relief for the tools in his accounts for the year ended 31 March 2024. Any expenses purchased using the accruals basis but not paid for until using the cash basis should be disregarded as expenses under the cash basis because tax relief has already been allowed. Therefore, the expense of £300 is ignored in the 2024/25 tax year and the total expenses for this year are reduced by £300 as part of the transitional adjustments.
3. Under the cash basis, stock is deducted as a purchase expense. Brian has not yet received any tax relief for the £200 as it was an asset in his accounts for the year ended 31 March 2024 under the accruals basis. Therefore, Brian will make an adjustment to treat the closing stock as a purchase expense and will increase his expenses by £200 in 2024/25.
4. Brian still has a tax written down value left in his plant and machinery general pool for writing down allowances, this means that he has not yet received all the capital allowances for the full cost value of machinery purchased some time ago.  When moving to the cash basis, any amounts which still haven’t received full capital allowances are treated as a cash purchase upon joining the cash basis. Therefore, Brian will be able to treat the £1,500 as an expense in the 2024/25 tax year and no longer claim capital allowances.

  Many small businesses should not be affected by transitional rule 4 above because most plant and machinery capital expenditure will be covered by the annual investment allowance. Also, the small pools allowance means many residual capital allowances general pool balances for writing down allowance purposes are written off. Therefore, most small businesses will probably not have a capital allowances general pool balance. This rule does not apply to capital assets such as cars or land and buildings.