What Is The Difference Between Cash Accounting And Accrual Accounting On VAT?

When TBOS helps a new director start their first recruitment agency, one of the tasks we do is register the agency for VAT. Even though this isn’t a requirement as the agency hasn’t yet reached the £85,000 VAT registration threshold we know that this can make an agency appear larger to their clients and suppliers and they can also reclaim the VAT on their start up expenses and running costs.

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However, one of the things that we need to explain to the agency is the difference between Cash Accounting and Accrual Accounting when dealing with their VAT returns.

Often when a new agency starts they will be put on a Cash Accounting mechanism for VAT which means the agency will only have to pay over to HMRC the VAT on any VAT received from clients and reclaim any VAT on expenses and supplier invoices paid. This way of calculating VAT aids the agency cashflow as they don’t have to pay HMRC VAT on funds they have not received from their clients.

However, when an agency reaches £1.35m in taxable turnover (there is a 25% tolerance built in to around £1.6m) the agency needs to switch to the Accrual Accounting mechanism for VAT which means the agency will have to pay over to HMRC any VAT on invoices raised and offset VAT on any supplier invoices received.

The transfer between Cash Accounting to Accrual Accounting can come as a cash-flow shock to the agency as often there can be a large difference to pay over to HMRC between the schemes.

As part of the TBOS processes, TBOS keeps the agency updated on their VAT position on a monthly basis within the management accounts to help the agency understand what the potential VAT liability may be when the payment is due.

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