How to choose the appropriate accounting basis

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

From 28th April 2022, when you’re setting up a FreeAgent account for a sole trader or partnership, 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, nor is the cash accounting basis available in FreeAgent for non-UK-based business. It’s also not possible to change your accounting basis once your FreeAgent account has been set up. However, if you choose the wrong basis when setting up your FreeAgent account, you can reset your data to go through the setup stages again and choose the correct basis.

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

  • CIS
  • Payroll
  • Self Assessment
  • Stock

Differences between the accruals and cash accounting bases in FreeAgent

The main differences between preparing your accounts using the accruals accounting basis or the cash accounting basis are 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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