Concepts
Cash basis
The cash basis is an accounting method where income is counted when you receive payment and expenses are counted when you pay them, rather than when invoices are issued or received.
Under the cash basis, you record income in the period you actually receive the money and expenses in the period you actually pay them. If you invoice a customer in June but are paid in August, the income counts when the payment arrives. If you receive a supplier's bill in June and pay it in July, the expense counts in July. This makes the method easy to understand because it follows the bank account.
For income tax, many small businesses and individuals use a cash approach, often described as accounting for income when it is received. Small businesses that meet the relevant tests can choose it, while other entities may be required to use an accruals approach to reflect income as it is earned. The rules about who can use which approach are set by legislation, so confirm your eligibility with the ATO or an adviser rather than assuming.
For GST, the equivalent concept is accounting for GST on a cash basis. If you are eligible and choose it, you report GST on sales in the tax period in which you receive payment, and claim credits on purchases in the period in which you pay for them. Eligibility has generally depended on your GST turnover being under a set threshold or on running a business that meets certain conditions, so check the current test on the ATO website.
A practical benefit is cash flow. If you invoice a $5,500 job and your customer takes 60 days to pay, on a cash basis you do not owe the $500 GST to the ATO until the period in which payment is received. This can ease pressure on businesses with slow-paying customers. The trade-off is that credits on purchases are also deferred until you pay your suppliers.
Record keeping is still essential. The cash basis does not mean you can ignore invoices. You must still hold tax invoices to support GST credits, and records of sales and payments need to be kept for the required period, generally five years. Bank reconciliation is the main tool for confirming that every receipt and payment is recorded in the correct period.
Common misunderstandings include thinking the cash basis for income tax and GST must be the same, when they can be chosen separately in some circumstances. Another is forgetting about the switch: if you change method, adjustments are generally required so amounts are not counted twice or missed. It is also wrong to assume that cash accounting avoids GST, as it only affects timing. This is general information only, so confirm what applies to you with the ATO or a registered tax professional.
Worked example
A carpenter completes a job on 20 September and invoices $11,000 including $1,000 GST. The customer pays on 5 November. On the cash basis, the $1,000 GST is reported in the October to December quarter, not the July to September quarter. If he buys $2,200 of materials including $200 GST in September but only pays in November, the $200 credit is also claimed in the later quarter.
Practical tips
- Ask the ATO or your adviser whether you are eligible before using the cash basis, since eligibility rules apply.
- Reconcile your bank account regularly so receipts and payments land in the right period.
- Remember you still need a valid tax invoice to claim credits, even on a cash basis.