When to account for income and expenses: part 1

Emily Coltman

Chief Accountant

It’s not always easy to know when income and expenses should go into your profit and loss account.

Some issues that often result in a bit of head scratching are:

  1. Is income included:
    a. when the work is done,
    b. when the invoice is raised, or
    c. when the customer pays?
  2. Is a cost included:
    a. on the date of the bill, or
    b. on the date the bill is paid?
  3. If a cost is paid for by credit card and there's no bill, is that cost included:
    a. on the day the credit card is presented to the supplier, or
    b. when the business pays off the credit card balance from its bank account?
  4. If a cost is paid for personally and then the business pays the individual back, is that cost included:
    a. when the individual incurs the cost, or
    b. when the business pays the individual back?

Let’s look at each of these in turn.

1) Income

When should income be included in your profit and loss account?

The most strictly accurate answer is a) when the work is done.

For small businesses who prepare their accounts no more often than every year, the easiest way to do this is to make sure that you include all the work you did just before the end of the year for each client on an invoice to that client that’s dated within that year.

So if you’re preparing accounts to 31st March each year, make sure that you date invoices for work done in March on 31st March – not 1st April. It may be tempting to date the invoice later and pay your tax a year later, but that’s not allowed!

In some countries, small businesses are allowed to prepare their accounts on a “cash basis” and account for their income only when their customers pay them. In the UK that’s OK for VAT but not in a profit and loss account. Income must be included when you earn it.

2) Bills

Again, costs must be accounted for when they’re incurred, not when the supplier is paid.

So if you’re preparing accounts to 31st March and you have a bill dated 20th March 2011 that you don’t pay until 10th April, that bill goes into your accounts for the year ended 31st March 2011 – not 31st March 2012.

This is actually good news because it means that you get the tax relief on that bill a year earlier.

Sometimes suppliers charge in advance. For example, rent is nearly always payable in advance and so is insurance. You may need to carry costs forward by posting what accountants call “prepayments”.

And also you may be charged in arrears for some costs such as electricity. You may need to carry these costs back by means of “accruals”.

If you have an accountant then (s)he will be able to post prepayments and accruals for you.

3) Credit card payment with no bill

This one’s straightforward – the cost goes into your profit and loss account when you present your credit card to the supplier, not when you pay off the credit card balance.

So if you go to Staples on 10th March 2011 and buy a pack of box files, and you pay your credit card off with a bank transfer on 30th April 2011, the purchase of the box files goes into your profit and loss account on 10th March.

You may still need to post a prepayment or an accrual though, for a cost paid on a credit card.

4) Cost incurred personally

Again the cost goes into your profit and loss account when the individual incurs the cost, not when the business pays him/her back.

And now for the good news!

Except for any prepayments and accruals, FreeAgent will handle all this for you automatically!

This post should though help you understand what FreeAgent is doing with your income and expenses.

In the next post we’ll look at when you should account for VAT on each of these kinds of transactions.


Disclaimer: The content included in this blog post is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this blog post. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.

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