Many small business owners record their transactions using cash-basis accounting, but could the accruals method be more appropriate?
Business owners need to understand the difference and be aware of the implications of each method to decide which approach is best for their business.
Under the cash or receipts method, income and expense are recognised when it is received from customers or paid to the suppliers irrespective of when the invoice is issued or bills are received.
Under the accrual or earning method, income and expenses are recognised when it is earned or incurred (when the invoice is issued or bills are received) irrespective of when the income is received or bills are paid.
Many business owners when starting out often use a cash basis because of its simplicity and easiness in tracking cash flow. This method of accounting may be appropriate for micro businesses.
However, for most businesses, the accrual method of accounting may be more appropriate as it generally offers a more accurate picture of a company’s profitability, assets, and liabilities on its balance sheet.
In today’s business environment, it is more important than ever to monitor your debtors closely and have a good system in place to reduce the debtors’ days and avoid it becoming a bad debt.
For income tax purposes, the accounting method adopted should be the most appropriate for the business. ATO Tax Ruling 98/1 provides guidance on the appropriate accounting method to record your business transaction whether they should be on an accrual basis or on a receipt basis.
The receipts or cash method is likely to be more appropriate for businesses with personal service income, whereas the earnings or accruals method may be more appropriate for income derived from the business structure.
If there is any change in your circumstances, you may change your accounting method from cash to accrual. In such an event, any payment received in respect of the invoices issued on a cash basis should be included as assessable income. Similarly, any deductions that have not been accounted for because they were not actually paid should be deducted in the year in which the taxpayer changes to the accruals method.
It is possible to use different methods of accounting for GST and income tax. For example, you may use an accrual method for income tax purposes, but for GST reporting you may use the cash method. The accounting method for income tax purposes depends on the nature of the business while the right to choose a cash basis for GST depends on your turnover. If your aggregated turnover is less than $10 million, you have the right to choose cash or accrual methods for GST.
Get in touch with us if you have any questions or need help understanding which method of accounting is more appropriate and beneficial for your business.
Disclaimer: This article is provided as general information only and does not consider your specific situation, objectives, or needs. It does not represent accounting or tax advice upon which any person may act. Implementation and suitability require a detailed analysis of your specific circumstances. Before taking any action, consider your own circumstances and seek professional advice.