Cash accounting is a form of accounting in which transaction payments reported in the period in which they get received and record expenses in the period, in which they are paid. In other words, when money is earned and spent, respectively, profits and losses are registered. Cost accounting also refers to as cash-basis accounting.
Cash accounting does not operate for larger companies with a large inventory because it can misrepresent the actual financial situation. Therefore, when filing for VAT, many small and medium-sized businesses follow this process.
The Cash Accounting Scheme includes the recording of Value Added Tax by which VAT is reported based on payments either made or received. It follows the principles of cash accounting, which means that the revenue gets reported and document the expenditures at the time of payment when received. It is a scheme that every business needs to consider.
For many small businesses, a cash accounting scheme is a useful tool, as you only charge VAT to HMRC once you collect your payment. The system could be a lifesaver if you're concerned about cash flow. It is different from the standard VAT accounting scheme under which you pay/reclaim VAT whenever an invoice is sent or received.
If your expected revenue for the next tax year does not exceed £ 1.35 million, you can join the cost accounting system. Likewise, once the revenue hits £ 1.6 million, you must leave the system. On the other side, whether you are behind on your VAT returns or have additional VAT payments, you are not eligible to use this scheme. Besides this, another reason includes that you have not committed a VAT violation such as tax evasion over the past 12 months.
You do not need to inform HMRC if you enter the cash accounting scheme. Nevertheless, you should register at the beginning of a new accounting period. Similarly, you should leave the system after the end of an accounting period.
Following types of transactions are not covered by the cash accounting scheme:
The Cash accounting scheme increases cash flow for many organizations as you do not have to charge tax before receiving your payment. Unlike the Standard Accounting Scheme, the cash accounting scheme prohibits businesses from paying VAT on unpaid invoices.
It is particularly useful if you have many customers paying late regularly or if you encounter bad debt from customers not paying invoices. The scheme is also flexible because if their business priorities change, the taxpayer has an option of switching from cash to accrual basis. Moreover, the preparation of accounts would be easier because businesses do not have to make accounting changes at the end of the year.
The scheme can cause problems if you get paid immediately, or if you collect more VAT regularly than you spend. This way, it is less likely to benefit your company. Similarly, this system also guarantees that you will not be able to reclaim VAT on purchases until the manufacturer gets paid. It can be troublesome for companies that buy a lot of credit inventory.
It's easy to stay on top of the cash accounting scheme with Debitoor invoicing technology. You can also apply Value added tax on your invoices and expenses. It will enable your account settings and automatic VAT reports on a monthly, quarterly or annual basis.
You have to quit the program if the taxable income reaches £ 1.6 m but at the end of the VAT quarter. You don't have to inform HMRC before leaving the scheme, but you need to keep records of what you did and your calculations for VAT.