Accounting Methods for Business

Methods of accounting for business income and expenses

 

Your business may need to use one method of accounting for income tax purposes and a different method of accounting for GST purposes.  The available methods are listed below. 

 

There are 3 methods recognised for income tax purposes:

 

If your business is not eligible to use the STS accounting method, then it must use either the accruals method or the cash method, depending on which is deemed ‘most appropriate’ for your type of business.

 

As a general rule all businesses not eligible to use the STS accounting method must use the accruals method unless they qualify to use the cash method.

 

1. STS accounting method – ordinary income is assessable when constructively received (collected); expenses are deductible when paid

 

Prior to 1 July 2005 an STS Taxpayer had to use the STS accounting method.  After that, STS Taxpayers who used this method prior to 1 July 2005 could elect to continue to use it, provided they continued to be eligible to be a STS taxpayer.  The STS system was repealed on 30 June 2007 and replaced by the Small Business Entity System (SBE).  But those pre 1 July 2005 STS taxpayers, who were still legitimately using the STS accounting method at 30 June 2007, can continue to keep using the STS accounting method, for so long as they continue to qualify as a Small Business Entity (SBE).  To continue to qualify as an SBE your annual aggregated turnover must be less than $2 million.

 

 2. Accruals Method – ordinary income is assessable when earned (includes receipt of income which is not refundable); expenses are deductible when incurred. 

 

Income is deemed to be earned when there is a collectible debt due to the business.  A debt becomes collectible in accordance with the normal business practice of the business. 

 

For example, if the business normally bills at the end of each month, then recoverable work in progress will be deemed earned at the end of each month, even if an invoice has not been issued yet.

 

3. Cash Method (Receipts Method) – ordinary income is assessable when constructively received (includes receipt of money which is not refundable); expenses are deductible when incurred.

 

A business will generally qualify to use the cash method if the income earned is personal services income (PSI), unless the business has a large (?) number of principals and employees. 

 

PSI is income that is mainly a reward for an individual’s personal efforts or skills.

 

Examples of PSI are:

 

Ø      income of a professional practitioner in a sole practice or small (?) practice

 

Ø      income payable under a contract which is wholly or principally for the labour or services of one person or a small (?) number of persons

 

Ø      income derived by a professional sportsperson or entertainer from the exercise of professional skills

 

Ø      income derived by a consultant in business from the exercise of personal expertise.

 

PSI does not include income that is mainly: 

 

Ø      for supplying or selling goods (for example, from retailing, wholesaling or manufacturing)

 

Ø      generated by a significant income-producing asset (such as a bulldozer)

 

Ø      for granting a right to use property (for example, the copyright to a computer program)

 

Ø      generated by a large business structure (for example, a large (?) accounting firm).

 

(?) The above is based on the principles enunciated in IT2503 and IT25.  The concepts of small and large have not been specifically defined for the purpose of determining the most appropriate accounting method. 

 

The method of accounting for GST affects when you must account for GST to the Australian Taxation Office and when you are able to claim input tax credits. 

 

There are 2 methods of accounting recognised for GST purposes:

 

1. Cash Basis

 

Ø      GST on income is reportable in the period when it is effectively collected.

 

Ø      GST on expenses is reportable in the period when it is effectively paid.

 

2. Non-Cash Basis            

 

Ø      GST on income is reportable in the period when it is effectively invoiced by your business.

 

Ø      GST on expenses is reportable in the period when it is effectively invoiced to your business.

 

You may choose to account for GST on a cash basis if:

 

Ø      from 1/7/2007, your annual aggregated turnover is less than $2million (previously $1million) or;

 

Ø      you legitimately account for your income (for income tax purposes) on a receipts (that is, cash) basis; or

 

Ø      you are a charitable institution; or

 

Ø      your enterprise is of the kind that the ATO determines, in writing, is the kind of enterprise that may use a cash basis.

 

All other businesses must use the non-cash basis to account for GST.

 

S A M (Simplified GST Accounting Methods)

 

In addition there are 5 simplified GST Accounting methods that may be available to eligible small food retailers depending on their turnover, the nature of their business and the nature of their point of sale equipment.  These methods determine how to estimate the GST free sales and/or purchases.

 

Ø      Business Norms Method – apply standard percentages to sales and purchases.

 

Ø      Stock Purchases Method – take a sample of purchases and use this sample.

 

Ø      Snapshot Method – take a snapshot of sales and purchases and use this.

 

Ø      Sales Percentage Method – work out what percentage of GST-free sales made in a tax period and apply this to purchases.

 

Ø      Purchases Snapshot Method – take a snapshot of purchases and use this to calculate GST credits.

 

For more details refer to the links below.