Framework for preparing accounts on a cash basis for income tax purposes

From the tax year 2024/25, the default basis for calculating the taxable profit or loss of an unincorporated business became the cash basis. As a result, many self-employed and unincorporated businesses will now be preparing their accounts, which form the underlying basis for the taxable profits, on a cash basis.

While the cash basis now applies as the default, unincorporated businesses can still opt out of the cash basis and continue with traditional accruals-based accounting. There are well established principles for traditional accounts (UK Generally Accepted Accounting Principles or UK GAAP) but there is no similar framework for the preparation of accounts on a cash basis. 

While it may seem unnecessary to consider how cash basis accounts should be prepared as they should simply reflect monies received and monies paid, there are some factors which might remain unclear. For example, should tax adjustments be incorporated, what are the responsibilities of the professional accountant in the preparation and what sort of accountant’s report should be prepared? 

Framework for preparing accounts on a cash basis for income tax purposes 

We are issuing the following guidance to our members in relation to their professional responsibilities when a cash basis accounts preparation engagement is undertaken and the form and content of any report issued in connection with this engagement. This guidance, as an indication of good practice, is intended to be persuasive rather than prescriptive.  

This guidance should be read in conjunction with the Framework for preparation of accounts (the Framework), and in particular the following sections: 

• Confidence gained by users 
• Objective of an accounts preparation engagement 
• General principles of an accounts preparation engagement  
• Defining the terms of engagement 
• Documentation and planning  

These sections are as applicable for cash basis accounts as for traditional accruals-based accounting. 

Content of accounts 

The primary statement of account will be the ‘Income and Expenses Account’. 

As the accounts are being prepared for tax purposes, one of two approaches can be adopted: 

1. The accounts can show actual receipts and payments with a separate tax computation prepared to reconcile tax adjustments to the figures to be included in the tax return. 
2. The accounts can incorporate tax adjustments (for example, simplified expenses – see below) on the face of the accounts such that they equate directly to the figures to be included in the tax return. If this approach is used then this should be made clear to readers, for example by entitling the account ‘Tax adjusted Income and Expenses Account’. 

Ordinarily balance sheets won’t be prepared as part of the accounts. Where records are maintained electronically using an accounting system, then balance sheet nominal codes will be maintained (for example, bank accounts, proprietors drawing and capital accounts). It’s not however necessary to incorporate a balance sheet into the accounts to be approved by the business owner(s). 

In some circumstances. it may be appropriate to include ‘Notes to the accounts’ to provide clarity on how certain matters have been accounted for, for example VAT (see below), where there are different permitted treatments. 

Procedures 

Paragraphs 19-22 and 25-29 of the Framework remain applicable.  

You would normally undertake, as a minimum, the following procedures in order to be satisfied as to the proper recording and classification of the major entries in the accounts: 

• Obtain and check the bank reconciliation(s). 
• Investigate any unusual items. 

In addition, where a cash basis balance sheet is being prepared the following procedures would normally be undertaken: 

• Vouch significant capital receipts and payments (see below) to supporting documentation. 
• Perform a VAT reconciliation (if the client is VAT registered and the business chooses to record income and expenditure net of VAT – see below). 

The above list isn’t exhaustive, and the nature of the procedures performed will vary according to the engagement. 

Other matters 

VAT – Business income and expenses can be recorded either excluding or including VAT. Income and expenses must be treated the same way (i.e. both income and expenses are shown VAT inclusive, or both are shown net of VAT). 

If income and expenses are recorded VAT inclusive, then VAT payments made to HMRC should be shown as a category of payments and VAT repayments received from HMRC shown as a category of income. 

PAYE/NIC – Deductions for employee payroll costs and employer NIC which will require to be paid across to HMRC should be recorded only when paid.  

Simplified expenses - Instead of calculating expenses for running a vehicle, working from home and making adjustments for living on business premises, simplified expenses may be used instead. As simplified expenses aren’t actual payments but a tax adjustment, these can either be incorporated into the Income and Expenses Account or dealt with through the tax computation. 

Capital receipts and expenses, etc - HMRC’s internal manual - Business Income Manual at section BIM72005 onwards sets out HMRC’s expectations of how certain items of receipts and expenses would be treated. This includes dealing with capital receipts, capital expenditure, and interest payments and incidental costs of obtaining finance.  

Approval of accounts 

Written approval of the accounts, normally evidenced by a signature on the Income and Expenses Account should be obtained prior to signing the Accountant’s report. There is no statutory format of approval, but we have provided example wording below: 

I[/We] confirm that the Income and Expenses Account has been prepared on a cash basis in accordance with the requirements of section 24A of the Income Tax (Trading and Other Income) Act 2005 and that no election has been made under section 25C(1) of the Income Tax (Trading and Other Income) Act 2005 for the profits of the business to be calculated in accordance with generally accepted accounting practice. 

I[/We] approve the Income and Expenses Account for the year[/period] ended [………………]. 

Accountant’s report 

An accountant’s report should normally be attached to the accounts which have been prepared to make clear to users the extent of the firm’s involvement with those accounts. 

The report would normally include the following: 

1. A title – identifying the persons to whom the report is addressed. 
2. A statement that the firm has prepared the accounts on a receipts and payments/cash basis from the business’s accounting records and from information and explanations supplied by the client.  
3. A statement that chartered accountants are subject to the ICAS Code of Ethics. 
4. A statement that the report is made to management in accordance with the terms of the engagement. 
5. A statement that, to the fullest extent permitted by law, no responsibility will be accepted for the work or the report to anyone other than management as a body.  
6. A statement that the firm hasn’t carried out an audit of the accounts, verified the accuracy or completeness of the accounting records or information and explanations supplied, and that no opinion is expressed on the accounts. 
7. The name, signature and address of the firm and any appropriate designation. 
8. The date of the report. 

While it’s recommended that statements d), e), and f) are included in the report, this is ultimately a risk management decision for each firm. 

Illustrative example of chartered accountant’s report in relation to preparation of accounts under the cash basis 

Report to the Owner(s)/Partners on the Unaudited Accounts of XYZ 

In accordance with the engagement letter dated [insert date] we have prepared for your 

approval the accounts of XYZ for the year ended [insert year end] as set out on pages [insert page numbers] on a cash basis from the accounting records and information and explanations you have given us. 

As a practising member [/member firm] of ICAS, we are subject to its ethical and  

other professional requirements which are detailed at https://www.icas.com/regulation-technical-resources/regulation/ethics/icas-code-of-ethics 

[This report is made solely to you, in accordance with the terms of our engagement  

letter dated [insert date].] Our work has been undertaken solely to prepare for your approval the accounts of XYZ in accordance with the requirements of section 24A of the Income Tax (Trading and Other Income) Act 2005.  

[To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than you, for our work or for this report.]  

[We have not been instructed to carry out an audit or a review of the accounts of XYZ. For this reason, we have not verified the accuracy or completeness of the accounting records or information and explanations you have given to us and we do not, therefore, express any opinion on the accounts.] 

Signature 

Typed name of accountant  

Address 

Date