It’s the end of the financial year and we are discussing with client’s their profit and it is common that each year a number of our clients in business (small and medium business enterprises SME) are confused by the difference between Cash and Accruals accounting.
This confusion stems from mixing up concepts from BAS/GST, Taxation and Accounting.
I recommend you speak to VJC or your adviser if you are unclear after reading this article, to simplify the explanation I have generalised and made a few assumptions to apply to the majority.
BAS/GST
When you register for GST you can choose to account for GST on a cash or accruals basis (cash basis is only available only if your aggregated business turnover is less than $10M).
Most businesses choose Cash basis so they pay GST only on income they have actually been paid and received, Accruals goes by the invoice date.
Payment is when you have been paid or otherwise received.
Taxation
When completing you tax returns you do not really get a choice of cash or accruals, quoting the tax ruling TR 98/1 “a taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate.”
The simplest example I can give is that the appropriate method for a salary and wage earner is a cash (receipts) basis and for a company it’s a virtually always an accruals basis. Most businesses will account on an accrual basis, most run an organised operation and record Accounts Receivable (debtors) and Payable (creditors).
Some expenses are not tax deductible and need to be removed, added-back, in your tax return e.g. unpaid super.
Accounting, financial statements, profit and loss and balance sheet.
For most SME your Accountant will try to match your tax returns and your financial statements but there are adjustments that need to be made to remove non-deductible items for tax.
Most/all small businesses will not prepare general purpose financial statements (as a public company does) instead they simply base the financial statements on generally accepted accounting principles i.e. what is an asset, liability, income, expense etc.
Accounting includes all transactions that have happened, they are either a Debit or a Credit, the items value is the amount paid or received (known as the historical cost).
The confusion of cash and accrual can be understood if you remember that your Profit and Loss is not Cash Flow statement and so it will include income not received in many cases particularly if you have your Accounts receivable in your balance sheet as an asset i.e. the profit and loss will record the Income, as every Debit has a Credit.
This is why Accountant’s have a job and why you need a good accountant, it is because the law is difficult to interpret unless this is your profession!
To work out the above you could read:
- TR 98/1 – Income tax: determination of income; receipts versus earnings will tell you there are 2 main methods, the receipts basis (cash) and the earnings method (accruals) and whilst Income is assessable when it is derived you must choose the most appropriate method.
- TR 97/7 – Income tax: section 8-1 – meaning of ‘incurred’ – timing of deductions if you are interested you can read also about deductions, you can claim the deduction when it is incurred.
Remember tax and reading are fun!!!!
General Advice warning: the information in this article is general in nature, it is not advice specific to your needs. If you want to act upon the information in this article then you should seek advice from a qualified professional. VJC WM accepts no liability to any party for acting from this information unless they have sought advice in a formal engagement with VJC WM for this purpose.
