Choosing the appropriate accounting basis

This article explains the differences between the cash accounting basis and the accruals accounting basis in FreeAgent.

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Accounting basis basics

When you’re setting up a FreeAgent account for a sole trader, partnership, or unincorporated landlord, you can choose to prepare your accounts using the ‘Traditional (accruals) basis’ or ‘Cash basis’. This is different from using the cash basis to prepare your VAT returns, so please check with your accountant if you’re unsure which basis you should be using for your accounts.

Please note that it’s not possible to use the cash accounting basis to prepare accounts in FreeAgent for a limited company or limited liability partnership, as this is not permitted by UK law. The cash accounting basis is also not available in FreeAgent for non-UK or universal account types.

Additionally, HMRC only permits businesses to begin using the cash accounting basis if their turnover is £150,000 or less per year.

If you choose the wrong basis when setting up your FreeAgent account, find out how to switch your accounting basis.

The following functionality won’t be available if you’re preparing your accounts using the cash accounting basis:

  • Payroll
  • Stock

Differences between the accruals and cash accounting bases in FreeAgent

The main difference between preparing your accounts using the accruals accounting basis or the cash accounting basis is when your income and costs will be recorded on your profit and loss report in FreeAgent.

There are also certain costs that aren’t allowable for tax relief when you’re using the cash basis, such as bank interest over a limit of £500. Please see HMRC’s guidance for more information.

Income

When preparing your accounts using the accruals accounting basis, income is recorded when the income is earned. On this basis, when you create an invoice in FreeAgent, the income will be recorded on your profit and loss report on the invoice date.

This is different to preparing accounts using the cash accounting basis, where income is recorded when the money has been received from the customer. On this basis, when you create an invoice in FreeAgent, the income will only be recorded on your profit and loss report once the invoice has been marked as paid.

Costs

When preparing your accounts using the accruals accounting basis, costs are recorded when the costs are incurred. On this basis, when you create a bill in FreeAgent, the cost will be recorded on your profit and loss report on the bill date.

This is different to preparing accounts using the cash accounting basis, where costs are recorded when the money has been paid out. On this basis, when you create a bill in FreeAgent, the cost will only be recorded on your profit and loss report once the bill has been paid.

When you create an out-of-pocket expense, the cost will be recorded on your profit and loss report on the expense date when preparing your accounts, regardless of whether you’re using the cash or accruals accounting basis.

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