Understanding Cash Basis and Accruals Basis for Your Accounts and Tax Return in the UK

As a musician, you probably spend most of your time thinking about your music, not about finances. But when it comes to managing your money and filing your tax return in the UK, it’s important to know some basics. Two key terms you might come across are the “cash basis” and the “accruals basis.” Let’s break down what these mean in simple terms!

What is the Cash Basis?

The cash basis is a way of keeping your financial records based on when money actually moves in or out of your bank account.

• Income: You only count the money you’ve received. For example, if you played a gig in December but didn’t get paid until January, you would count that income in January.
• Expenses: You only count expenses when you actually pay them. If you bought a new guitar in June but didn’t pay for it until July, you count the expense in July.

This method is straightforward because it matches your bank statements. It’s easier to track and understand, making it perfect for small businesses and self-employed people like musicians. In the UK, if your income is under £150,000 a year, you can choose to use the cash basis for your tax return.

What is the Accruals Basis?

The accruals basis is a bit different. Here, you count income and expenses when they happen, not when the money actually changes hands.

• Income: You count income when you’ve done the work, even if you haven’t been paid yet. If you performed at a festival in November, you would count that income in November, even if you don’t get paid until December.
• Expenses: You count expenses when you’ve committed to them, not necessarily when you pay for them. If you order a new microphone in March but pay for it in April, you count the expense in March when you ordered it.

The accruals basis gives a clearer picture of how your business is doing month-to-month or year-to-year because it matches income with the expenses that relate to that income. It can be more complicated, though, and is usually used by larger businesses.

Buying a Computer or Musical Instrument on Finance: Cash vs. Accruals Basis

If you buy something expensive on finance, like a computer for £1,000 or a violin for £10,000, the way this is treated in your accounts can differ significantly depending on whether you use the cash basis or the accruals basis.

• Cash Basis: Under the cash basis, you only record expenses when you actually pay them. So, if you buy a computer or a violin on finance and make monthly payments, you will only record each payment as an expense when it is made. This means that if you bought a £10,000 violin and are paying £200 a month, you would only show the £200 payments as expenses in your accounts as you make them. The full cost of the violin doesn’t appear all at once in your accounts, which can make it look like you’re spending less in the short term.
• Accruals Basis: Under the accruals basis, you record the entire cost of the item when you make the purchase, even if you haven’t paid for it yet. So, if you bought the £10,000 violin on finance, the whole £10,000 would be recorded as an expense at the time of purchase, not when you make each monthly payment. This reflects the fact that you’ve committed to spending £10,000, even if the payments are spread out over time.

Why Does This Matter?

The difference between these two methods can affect your tax return and how you understand your financial situation:

• Cash Basis Pros: It’s simpler and shows you what you’ve actually paid out, which can help with cash flow management. However, large purchases on finance will appear as smaller, spread-out expenses, which might not fully reflect your financial commitments.
• Accruals Basis Pros: It gives a clearer picture of your total commitments and can help you see the true cost of running your music business. But it can also make your expenses look higher upfront, which might affect your taxable profit and cash flow management.

Which One Should You Choose?

For most musicians and small business owners, the cash basis is simpler and more straightforward. It’s easier to manage because it follows the actual flow of money in and out of your accounts. However, if you have a more complex business or want a clearer picture of your finances, especially if you’re making big purchases on finance, the accruals basis might be better, but it requires a bit more accounting knowledge.

Final Thoughts

Whichever method you choose, it’s important to keep good records of your income and expenses, including any big purchases made on finance. This will help you prepare your accounts and tax returns accurately and avoid any surprises. If you’re ever unsure, it’s a good idea to chat with an accountant or a financial advisor to make sure you’re on the right track!

Happy playing, and keep those finances in tune!

 

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