Emily Coltman, who suggested AccountingWEB's campaign for cash accounting has posted a comment on my feature on this subject. Because I think it worth drawing to wider attention I am posting my response here.
Emily seems to concede my point that the management of working capital (debtors, creditors and stock in the UK, receivables, payables and inventory in the US) is vital in small business, and that accountants have a duty to talk about them. But she then says:
Not including them in the accounts is a different matter entirely.
I have to disagree. Tax is a powerful influence on behaviour, especially in the business community. So the choice of accounting method is very important. If people are allowed to account on a cash basis for tax they will do these things:
- delay collection of debtors
- advance payments to creditors
- overstock
- buy too many fixed assets if 100% capital allowances are implicit.
What is more, some accountants will tell them to do this. The outcome will be disastrous for UK small business. There can be no doubt some will go bust as a result. These strategies are designed to drain these businesses of money. Nothing can guarantee failure as quickly as that.
But more than that, if accountants can (and would) educate them to do this even though it would be suicidal, small business people can clearly demonstrate their ability to grasp issues relating to these matters. It's just that most accountants can't be bothered to tell them about them. I have always tried to advise my clients of the basis on which their accounts have been prepared, because I think this important. For example, I attach the notes to the accounts (which are menu driven and so not always used in all cases) which I have appended to unincorporated business accounts in the firms I have been involved with over the last decade. Their purpose is simple. The notes are about client education, and people do read them and learn from them. But I've never seen anyone else do anything like this. Why not, I wonder? Wouldn't the problem be solved if we did this?
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Hi Richard.
Just to get a point straight – I didn’t suggest the campaign itself, Nichola Ross Martin and her team did that. I just suggested its name.
I would dispute your point that “most accountants can’t be bothered” to explain points to clients.
The point is that clients are not accountants and therefore *should not have to* understand complicated accounting concepts. If that’s what they wanted to do, they would have become accountants.
What I’m campaigning for is a simpler system to make life easier for clients. If they want to drain cash out of their business, they’ll do that anyway via drawings.
Further to your earlier posting, if a campaign is not worthwhile purely because the government won’t agree – that’s a bit defeatist, surely? If the Suffragettes had thought that way, women might never have been able to vote in the UK.
M
The last two arguments are internally inconsistent Richard. In your earlier argument, you say: “The rules for accounting are not set by our taxation authorities.” and in this discussion you say: “Tax is a powerful influence on behaviour.” From my vantage point that’s called having it both ways.
Dennis
Your grasp of logic is normally impeccable, so I’m surprised at your comment, and have to say that I think you are wrong.
As a matter of fact the rules of accountng in the UK are not set by our taxation authorities. UK GAAP applies, and that’s set by our accounting standards setters.
But that does not mean that tax has ceased to be a powerful driver of behaviour, or that if cash accounting was adopted by standard setters as this campaign suggests appropriate that the outcomes I think likely would not arise for tax planning reasons. You’re old enough Dennis to remember stock relief, 100% automatic FYAs and all the influence they had on commercial behaviour, for example. Rules that encourage abuse result in abuse is my argument. Cash accounting would encourage abuse.
So what’s the disconnect? Both are statements of fact. Both are true. Neither undermines the other. I’m baffled as to where there is a failure of logic.
Richard
Emily
I’m afraid I cannot agree with very much of what you say. People don’t want to become health and safety experts when they go into business, put have a public duty to at least learn the rudiments. The fact that someone does not want to do something does not make it desirable that they do not do it. And the fact is that people do go into business voluntarily, and if that’s what they want to do they won’t succeed unless they do learn to account – so in fact to a very large extent in this case the need to learn is not an obligation, it is pretty much a condition of success. In other words, it’s not a burden.
Nor can I agree that I’m being defeatist. Look at what I campaign for and it’s hard to suggest I either lack vision, or hope. My point is that choosing the outcome that is likely to achieve most of what you want with the highest degree of probability is a fundamental element of good campaigning. You and I agree that small business accounting is burdensome now. I agree that the FRSSE requires directors to sign acounts they could never undertsand. BUT I don’t think cash accounting is likely to be acceptable to our taxation authorities (even if it were to standards setters – and here maybe Dennis is right – I am being inconsistent except that I think the standard setters would be sat on by government to get them to agree) because of the damage to taxation revenues. So the best option for winning reform is to target the standard setters and go for a much, much simplified form of standard for micro businesses written in plain English with the accruals concept stripped to its essential components and vital issues, such as when a balance sheet is even needed, being addressed. That would help. And could win wider support, and it would not harm business by its implementation. As a result that’s winnable. Cash accounting is not. That’s my point.
Richard
Hi Richard.
In a sense we both want the same thing to happen – simplification of the accounting rules for small businesses.
The difference is that I support cash accounting and you don’t.
I’m also not sure that all business owners should learn full accounting – trying to teach them debits and credits would lose a lot at the first hurdle, it took me weeks to get to grips with that and I’m an ACA!
We could debate this for hours, so shall we agree to disagree?
M
Emily
We can of course agree to differ – and retain respect!
But I will continue to argue my cause
Richard
Richard – the logic works when you consider that I am applying a Foucault approach that requires context in order to make connections. In this case, I’m arguing that putting tax into the two contexts but for wholly different reasons doesn’t make sense.
I’ll make another objection which may be more palatable. Accounts as currently formulated relate to an industrial world where the emphasis is on bricks and mortar (and other tangible) value and where the P&L is even more industrial focused: ‘COGS’
For most small businesses, what matters is cashflow. It is a much easier concept to understand. So what’s the issue of adopting cash based accounting for those who use the cash based VAT system. I don’t recall many objections when that came in. This is no different.
The argument about BS stuffing and income deferral doesn’t stand up, except in the context of a one time deferral. You and I both know it is unsustainable to simply keep stashing larger and larger lumps in creditors or deferring billing before you initiarte a cash crunch. A cash based system solves that issue to some extent.
Finally – you are assuming that most accountants would encourage and condone such activity. That’s a pretty dim videw of the world don’t you think?
Dennis
I admit I’m bemused by your comments. Let’s deal with the last issue first. Of course accountants will get their clients to defer collection (or at least the banking of cheques) and get them to advance payment, and so on. Just look at the average comment on AccountingWEB. Most of them will claim it’s their duty to do so. Just as most of them incorporated hoards of clients to save a few quid and then complained that the rules changed. Accountants are that daft. Sorry to put it so bluntly, but the evidence suggests it’s true. So let’s be realistic about this. The abuse will happen, and either the number of investigations will rise significantly or the Revenue will do all they can to stop this happening. I bet the latter.
Second, in the contextual sense you mention, the above opinion is in my view relevant.
Third, in the case of small business one time balance sheet stuffing is enough to kill in some cases. And I happen to doubt that it will be ‘one time’. I take my evidence from the 80s when stocks grew continually because of stock relief rules. People will not want the reversal of the one off benefit so will continually harm their businesses by letting tax wag the commercial dog.
But most of all, I simply cannot see any link between VAT cash accounting and what is being proposed here. VAT cash accounting is a cash flow management relief designed to ease a burden on business by requiring it to make payment within thirty days of a period end on unpaid debts. That was a specific relief to help cash flow, not to simplfy accounting. Candidly, for many people it does not in fact simplify accounting at all. They actualy issue VAT charges on an accruals basis so it is extra work to have to account for it a second way on a cash basis (which will also, I am sure be true for cash accoutning is adopted for tax where in the end two sets of records will be required and difficult ongoing reconiliations will be necessary).
Finally, how can there be two conceptual bases for accounting, one cash, one accruals? Where is the transiation. How is it dealt with? Even if cash accounting would be of benefit tp the market trader or small builder, what happens when their business grows? There is no logic available for a transition to accruals (or fair value) that I can see making sense, let alone being fair.
Accruals accounting may have its faults (accounting for fixed assets, failure to recognise human capital, misdescription of labour expense and so on) but it does encourage sound financial management. Cash accounting does the opposite. It would be negligent of the profession to endorse it, would show that this is now a tax plannign profession and not one dedicated to either accounting or business management if it did, and would worst of all be a waste of time – because I can’t see it happening without the most draconian anti-avoidance measures being attached. And look who will be moaning then. Accountants, of course.
Richard
Apologies coming to this late if I ahve missed something. Should we not also look at the potential for losses to a business where it has expenses it has not paid for or where it has received money in advance which it has to refund.
Cash accounting for me has no logic connection with evaluating the profitability of a business and can give some very misleading results. To me it would lead to a free for all which would have to be governed by some anti-avoidance rules (as already suggested) that probably take us back to accruals accounting (which is not to most difficult concept to grasp-if a business man cannot understand that he has to make a provision for payment perhaps he should give up)
It’s amazing, I have had my nose to the grindstone and missed all the fun.
This is really going to hurt me, but, I find I agree with Richard, I am not in favour of ‘CASE’, bye the way catchy name Emily.
The accruals concept is not something clients have to deal with anyway, small clients have always dealt with income/expenses and at the end of the year the accountant has asked the question ‘who and how much is owed to/from you’ to deal with the accruals side.
Those using software for invoicing etc already do accruals accounting without realizing it.
If you have another methods i.e. CASE then when starting in business it is yet another choice/decision to make.
Further down the line when either their business structure changes or the business grows, how is the leap into accruals accounting to be dealt with.
However, more importantly, you need accruals accounting to know where the business has been and is going, ‘cash accounting’ is okay for cashflow purposes but it’s not a way to run a business.
I know Emily would fight the corner of the little guy who wants to earn enough to keep heart and soul together, but I would say again he really doesn’t have to deal with accruals side of things that is the accountants job.
I am sure the debate will rumble on ……
Thanks to Jason and David (neither, I think, my natural allies) for concurring on this one. I was beginning to wonder if I was the only accountant left who believed in the credibility of what we really do.
Thanks Jason.
Looking at the latest results on Taxation’s website, 30% of respondents aren’t in favour of cash accounting, and that seems to be the general picture here, too.
The Quaker way of doing business is, if not everyone agrees on a particular idea that’s been suggested, to take time out to have a think and look for a possible alternative that’d be acceptable to everyone.
Richard, you’re a vehement opponent of cash accounting, and you’ve suggested a vastly simplified accounting standard for small businesses as an alternative.
Could you expand on what simplifications and safeguards you’d be looking for in this standard please?
M
Emily – that means 70% do asgree doesn’t it? more thasn enough to get a merger done 🙂
The main problem is this discusson only really takes the accountant’s view. Where is the client in all this?
Dennis
Sometimes we have a duty to lead the client in the right direction. That’s the whole justification for the professions.
Richard
PS Emily? Are you a Quaker? If so are you a member of The Quakers and Business Group?
I will blog re the standard I think desirable over the next week or so
Hi Richard,
Yes, I’m a Quaker. I’m not yet a member of The Quakers and Business Group, though I was thinking of joining.
I look forward to reading your blog.
M
[…] Why cash accounting is bad for business […]
Cash accounting would suit our business down to the ground. We are a small consultancy so do not hold vast amounts of stock. We have been in business for over 25 years so have a track record. But we need to keep our finger on the pulse so to speak and cash accounting provides an easy verifiable basis for knowing where we are (simple database and spreadsheet programmes). We became incorporated to limit liabilities but cash accounting should also apply to incorporated small businesses as well. Why should we have to pay Corporation tax on money that we have not received? If its good enough for VAT Tax then its good enough for Corporation Tax. There is a CASE for cash accounting for small businesses. Could it be that it is the Accountancy profession who are trying to prevent this occurring to safeguard their jobs?
Chris
Cash accounting is great until you fail to count those creditors and go bust
Richard
Richard
You may as well say
“Cash accounting is great until you fail to bill those debtors and go bust”
This is just bad business management and does not justify using a complicated accountancy method which to many small businesses is nothing more than smoke and mirrors.