Accrual or Cash Accounting for GST?
The difference between cash and accrual accounting and how to choose.
If you’re running a business, you have two major options of accounting for GST – accrual or cash accounting. All businesses with an annual turnover of greater than $75,000 must register for GST. This subsequently involves business activity statement (BAS) reporting obligations to the Australian Taxation Office (ATO).
If you’re a small-to-medium-sized business, you can choose either option. Larger businesses must use the accrual method of accounting.
We’ll briefly explain the difference between each method and its respective pros and cons.
What is Cash Accounting?
The cash method involves accounting for transactions when they happen. For example, when your business actually receives payment for a sale or makes a payment for an expense to a supplier.
The pros and cons of using the cash accounting method
Pros
- Cash accounting is a simpler accounting method to understand than the accrual accounting method — for this reason, it may be best for anyone running a small business.
- It enables easier management of your business cash flow than accrual accounting, especially your GST payments to the ATO.
- It enables you to see the short-term financial health of your business more easily.
- It’s especially suitable for businesses that have a high volume of cash transactions.
- You may not need the services of an accountant or tax agent to do your business books.
Cons
- Unlike the accrual method, the cash basis accounting method doesn’t include accounts receivable (debtors who owe your business money) or accounts payable (creditors your business owes money to).
- It may not give you an accurate picture of how your business is performing from a longer-term perspective.
What is Accrual Accounting?
The accrual method involves recording transactions when revenue is earned (which is not necessarily when payment is received) and when an expense is incurred (which is not necessarily when it is paid). The transaction is recorded as soon as revenue and expenses are incurred, not when they are actually paid.
It’s a reality that many businesses operate on payment terms (for example, 30, 60 or 90-day accounts). These delayed payment terms create accounts receivable assets and accounts payable liabilities. Under this method, as soon as an invoice is issued to a customer, the payment (and GST) are recorded.
The pros and cons of using the accrual method
Pros
- Unlike the cash method, the accrual method allows you to record accounts receivable and payable if your business accepts or uses payment terms.
- It can give you a better long-term picture of your business's performance than the cash accounting method.
Cons
- Accrual basis accounting isn’t as simple to understand as the cash basis accounting method.
- It isn’t as easy to manage your cash flow when you use the accrual accounting method. You may have to pay GST on sales before you actually receive payment from your customers.
- It doesn’t give you as accurate a picture of the short-term financial health of your business as the cash method.
- It’s not as suitable if your business has a high volume of transactions with terms of immediate payment. For example, if you complete a job or make a sale and money is received that same day.
- You are more likely to need the services of an accountant or tax agent to do your business books.
- You are unable to defer income into the next financial year for tax purposes.
Should you use the cash or accrual accounting method?
This depends on your individual business circumstances.
If your business has an annual turnover of less than $10 million and/or your annual GST liability is $2 million or less, you can use either method. To decide which option is best, you should weigh up the pros and cons of each method based on your specific business situation.
Many small to medium-sized businesses use the cash basis accounting method unless the pros of using the accrual method outweigh the cons.
If your business has an annual turnover greater than $10 million and/or your annual GST turnover is more than $2 million, you must use accrual basis accounting. Most larger businesses, therefore, must use it and it usually better suits their circumstances.
Cash and accrual accounting methods for GST differ quite a bit. If you're struggling to decide which method is best for your business, be sure to seek advice from a tax planning professional.
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