Accounting methods
Accrual based accounting
Accrual based accounting means that your income and costs are included in the year they relate to. This isn’t always the same as the year in which they are paid or received.
So for example, if you have a 5th April 2025 year end you may raise an invoice to a customer on 1 April 2025 which isn’t paid until 30 April 2025 this invoice is included in your income for the year ended 5th April 2025. This invoice will form part of your ‘trade debtors’ in your balance sheet.
And, using the same year end, if you receive an invoice from a supplier for goods you received before 6 April 2025 but you don’t pay this until 30 April 2025, this will still form part of your expenses for the year ended 5th April 2025. This invoice will form part of your ‘trade creditors’ in your balance sheet.
We list out below the other main adjustments you may need to make if you are accrual accounting.
Prepayments
When you post invoices from your suppliers into your bookkeeping package you will post it all in one month. But some of these expenses may relate to after your year end.
You should put an adjustment through to take these costs out of your overheads and post them to the balance sheet.
So this will make your accounting profit greater than your bookkeeping profit.
Accrued income
If you carry out work before your year end but don't invoice this until after your year end, you will need to include this income in your accounts - it will be posted as 'accrued income' and will increase your profit for the year.
Accruals
There may be costs which you have incurred but for which you haven’t received an invoice or which were invoiced after your year end.
You should put an adjustment through to add these costs to your overheads and post them to the balance sheet.
So this will make your accounting profit less than your bookkeeping profit.
Deferred income
If you've invoiced your customer for work which won't be carried out until after the year end, this won't be included in your accounts - it will be posted as 'deferred income' and will decrease your profit for the year.
Depreciation
When you buy an asset, you may either post it in your bookkeeping software to an asset account or you might post the whole cost to your profit and loss account in the year you purchase it.
If the asset purchased are significant, you may prefer to include the asset in your balance sheet and then charge a percentage of the asset cost to your profit and loss account each year (and also posted against your asset account in the balance sheet effectively reducing the asset value).
So this will make your accounting profit less than your bookkeeping profit.
Bad debts
You might have debtors showing on your balance sheet who are never going to pay – for example, they may have gone bankrupt.
You can put an adjustment through to ‘write off’ these debtors so they no longer show on your debtors report.
This adjustment will be posted to a bad debt expense account in your overheads.
So this will make your accounting profit less than your bookkeeping profit.
Cash based accounting
Under cash accounting, a business declares its profits based on its sales receipts less business expenses – there is therefore no need to adjust for prepayments or accruals. There is also no need to account for stock, WIP or bad debts.
LLPs are not allowed to use cash accounting.
For 2019/20 onwards you can’t start using cash accounting if your business receipts are higher than £150k.
There is also an exit threshold of £300k for 2019/20 onwards – so if you are currently using cash based accounting you will need to exit the scheme if your business receipts are higher than £300k.
In order for the partnership to use cash based accounting, all the partners must agree and must all adopt this approach.
Whilst cash based accounting may be simpler than invoice based accounting, bear in mind the following:
- If your business makes a loss you will not be able to offset these losses either against other income in the same tax year or against profits from a previous year. You will only be eligible to carry these losses forward.
- Under cash based accounting you can only claim up to £500 in interest and bank charges.
- Accounts drawn up under the cash basis may not be accepted by banks or other lenders if you are trying to get finance for your business. You may therefore still need to prepare accounts using the accrual basis.
- If your business is more complex (eg high levels of stock) then cash based accounting may not suit you.
Whilst it's difficult for us to determine which is the best method for you to use, for most small sole traders the cash basis will be the simplest and easiest. If we think you have made a mistake in the basis you have chosen we will let you know.