VAT: Cash vs Accrual Accounting

VAT: Cash vs Accrual Accounting

If your business is VAT-registered, or you are exploring the benefits of VAT registration, you must consider the different methods for accounting for VAT. 

VAT is generally accounted for on the basis that the VAT paid to suppliers is deducted from the VAT you collect from your customers and clients.

Depending on the balance of these payments, this is either calculated as your VAT liability, or where you pay more VAT than you are collecting, the amount of VAT you can recover from HM Revenue & Customs (HMRC).

The two most commonly used forms of VAT accounting are cash (based on bank receipts and payments) and accrual (based on invoices raised and received) – but which method is most suited to your business?  

Why use cash accounting for VAT?

Using the cash accounting method, you calculate the VAT when your invoices are paid by your customers, not when they are initially raised – this ensures that you only pay VAT to HMRC once your customer has paid and settled their invoice. 

However, this also means that you can only reclaim the VAT from HMRC on purchases where the supplier invoice has been paid. 

This method is generally seen as an easier approach on cash flow, as cash reserves aren’t required to pay HMRC for sales not yet collected, making it ideal for smaller to medium-sized businesses.

Businesses should be aware, however, that this method of accounting is only available if taxable turnover is less than £1.35 million in the next 12 months. You must leave the scheme if your VAT taxable turnover is more than £1.6 million.

You are also not allowed to use this method of accounting if:

  • You use the VAT Flat Rate Scheme – instead, the Flat Rate Scheme has its own cash-based turnover method.
  • You are not up to date with your VAT Returns or payments.
  • You have committed a VAT offence in the last 12 months, for example, VAT evasion.

Certain transactions are also not permissible under this method, such as where the payment terms of a VAT invoice are six months or more. 

Businesses with long payment terms on their sales invoices, credit control issues or businesses such as consultants with no real significant expenses each quarter, may benefit from using the cash basis for VAT.

Whilst the accounting for VAT may be on the cash basis if you are a Limited Company, these year-end accounts will be prepared on an accruals (invoice) basis and therefore you will need to provide all sales and purchases regardless of payment status.    

Why use accrual accounting for VAT?

This is the default option for VAT.

If you use the accrual accounting method you must calculate VAT based on when the invoice was either received or issued. 

This method of accounting is not concerned with when payments were received or made, which is why it is the preferred (and often required) form of accounting for larger businesses with a higher turnover.

If you intend to use this method of accounting, you should make sure that you have sufficient cash reserves to cover VAT payments to HMRC on unpaid invoices.

Businesses that typically have a VAT repayment each VAT period may wish to use the accrual-based scheme to reclaim the VAT refund more quickly.

VAT payments are typically due around five weeks after the end of the VAT quarter, so if your customers tend to pay you within two to three weeks of invoicing, the accruals scheme could be more appropriate.

Businesses need to consider which form of accounting is most suited to their business and seek advice from a qualified professional before adopting one or the other. 

If you need help finding the right VAT scheme for your business, please contact us at JLC. 

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