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Year End Payroll Compliance’s

by Sanjeev Archak Sanjeev Archak No Comments

As we welcome the New Year 2020, we must get ready to say good bye to the Financial Year 19-20. Every organization must prepare itself to handle a basket of employee related statutory compliance’s. Let’s explore the year end payroll compliance’s.

The Government has entrusted the employers with handling duties which are critical to employee’s finances. Accordingly, every employer has to:

  • Deduct taxes from employers
  • Contribute towards statutory components viz, ESI,PF,Bonus,Gratuity
  • Remit taxes & other dues to the Government
  • File returns with various Government departments

Deduction of Taxes

The Income Tax Act, 1961 mandates that it is the employer’s responsibility to deduct the correct amount of taxes from the salary of an employee. In order to arrive at the tax amount the employer must collect proofs of investments from the employees. It is these proofs which ultimately result in a Form 16, which is used by employees to file their tax returns. Here is what an employer must do:

  • Communicate to the employees about the need for investment proof
  • Clearly list out the documents which is called as “Proof”
  • If possible, hold multiple rounds of proof collection
  • Re-calculate the TDS based on proof submitted
  • Deduct the TDS from employees salary
  • Remit the TDS to the Government within due dates

In addition to the above, every employer must file E-TDS returns for the January-March quarter within the due dates. The credit of tax deducted from the salary is transmitted to an employee only when the E-TDS returns are filed. The TDS deducted by the employer appears in the Form 26AS of every employee from whom tax has been deducted.

Further, it is important to note that a Form 16/Form 12BA can be generated only when the employer files his E-TDS returns. The Government requires that the Form 16’s be provided to employees within certain due dates. The Form 16, so issued by the employer, contains all the information required by an employee to file his income tax returns.

What happens when there is salary from more than one employer?

Section 192(2) of the Income Tax Act deals with situations where an individual changes employers during the year. The Law requires that the employee provide to the present employer details of salary income received from the former employer and TDS done thereon. The present employer will be required to deduct taxes on aggregate amount of salary (including salary from the previous employer)

If the employee fails to provide these details, it will be likely that he will have to pay interest on the taxes owed at the time of filing the return.

Contribution to Provident Fund & Employee State Insurance

The Provident Fund rules require the employer to deduct 12% from the salary of every employee as “Employee’s Contribution to Provident Fund”. The employer contributes 12% from his side as “Employer’s Contribution to Provident Fund”.

The employee’s contribution to provident fund is allowed as deduction from income tax under Section 80C. It is imperative that the employer includes the PF contributions in the Form 16 of the employee.

In order to ensure PF gets computed correctly and remitted on time, the entire payroll process has to be automated. We recommend Zoho Payroll for effortless payroll processing.

Employee State Insurance scheme stipulates that employer & employee contribute 4.75% and 1.75% of salary to the Insurance scheme. This scheme is applicable to employees who have a salary of less than Rs 21,000. Further, employees are not eligible for an income tax deduction for contribution to this scheme.

Remit taxes & Filing returns with the Government

Every employer has the onerous responsibility of depositing the amounts deducted from the employees with the Government. These returns have to be filed within specified timelines:

Sl.No

Particulars

Due Date

1

TDS

Deposit of TDS by  7th of every month

2

Provident Fund

Deposit of PF by 15th of  every month

3

Employee State Insurance

Deposit of ESI by 15th of  every month

4

ETDS

Filing of ETDS by 31st of every quarter

Non deposit of statutory deduction will lead to penalties and even criminal prosecutions. It can have a worse impact on the business’s reputation, because compliance violations tend to cause customers to lose faith in the business.

Needless to say that being compliant with regulations is a best bet for any business. As more employees get added to the business, more automated compliance management must get. Here is where Integra Books can help. We have a unique solution where expert human resources use the best technology to manage your business. Get in touch today.

PS: As a related piece we recommend that you read our previous blog on payroll here

Understanding Debits and Credits

by Sanjeev Archak Sanjeev Archak No Comments

Every industry runs on jargon. These jargon often trip people. In the accounting world the tripwires are “Debit” and “Credit”. There is no doubt that Debit and Credit are the cornerstones of the accounting block. Understanding debits and credits will help a business owner read financial statements better than before.

What are Debits and Credits?

In a nutshell, debit represents all the money flowing into business and credit represents all the money flowing out of business. Most businesses these days use double-entry system of accounting. Under this system, every transaction has two legs i.e, a debit and a credit leg.The entire business is organised into individual accounts. For ease of understanding lets call these accounts as buckets

For example:

  • the cash in your bank account will be the  “Cash” bucket
  • the value of your  furniture will be the “Furniture” bucket
  • the bank loan taken by your  business will  be the “Loan” bucket

Whenever your business purchases furniture or repays or avails a loan the balances in these buckets changes. Recording the changes in these buckets requires a language other than English. That is where debits and credits come in. Often, accountants abbreviate debits and credits to dr and cr.

How do debits and credits operate?

In a business money doesn’t appear or disappear out of nowhere. Debits and credits are designed to track where money is coming from and where to it goes.

Let’s take an example where you decide to buy a piece of furniture for Rs 50,000, here is how it will look like in our bucket system:

  • Firstly, money will move out of the cash bucket, cash bucket stands credited for Rs 50,000
  • Secondly, the furniture bucket will increase by Rs 50,000

As mentioned earlier, in the double entry system every debit has a corresponding credit. Here is how the entry will look like:

Account Debit Credit
Furniture          50,000
Cash          50,000

An accountant would say that we are crediting the bank account for Rs 50,000 and debiting furniture for Rs 50,000.

How do debits and credits operate in liability accounts?

The cash and furniture buckets are “asset” buckets. There are “liability” buckets as well. Examples of liability bucket are business loans, share capital. Yes, your own share capital is a liability for the business. We will get to that later in this post. Let’s see how debit credit and operate when you borrow a loan of Rs 50,000:

  • Firstly, money will move into the cash bucket, cash bucket stands debited for Rs 50,000
  • Secondly, money will move into the loan bucket, loan bucket stands credited for Rs 50,000

This transaction has increased the cash and loan balances. Cash balance denotes what you have and the loan balance denotes what you owe. Here is how the entry will look like:

Account Debit Credit
Cash          50,000
Loan          50,000

How do debits and credits operate in equity accounts?

Let’s take a situation where you invest Rs 50,000 as equity share capital in the business, debit and credit will operate as under:

  • Firstly, money will move into the cash bucket, cash bucket stands debited for Rs 50,000
  • Secondly, money will move into the equity bucket, equity bucket stands credited for Rs 50,000

Why is it that crediting an equity account makes it go up, rather than down? That’s because equity accounts don’t measure how much your business has. Rather, they measure all of the claims that investors have against your business. Here is how the entry will look like:

Account Debit Credit
Cash          50,000
Equity          50,000

The Debit and Credit Thumb Rule

Here is a simple way to remember debits and credits in accounting:

Debit Credit
Increases an asset account Decreases an asset account
Increases an expense account Decreases an expense account
Decreases a liability account Increases a liability account
Decreases an equity account Increases an equity account
Decreases revenue Increases revenue
Always recorded on the left Always recorded on the right

If you’d rather not deal with debits and credits at all, try Integra. We’ll do your double-entry bookkeeping for you, all online, no matter where you are in world.

A Slackers Guide to Bookkeeping-The Lewbowski Way

by Sanjeev Archak Sanjeev Archak No Comments

Doing your books isn’t exactly a fun activity. You could be a slacker or a hardworking person, but there are definitely other entertaining things for you to do. So, we have come up with a slackers guide to bookkeeping.

Use technology to make it easier

Keeping track of receipts/bills is hard. You are likely to lose most of them. So use some simple tools which will make your life easy. Try using:

Cam Scanner:  A great way to digitize your receipts. Take a snap and store them forever. Also, don’t forget to send it to your accountant.

Zoho Expense: Lets you create expenses, store receipts. This also has an optical scanner for scanning receipts that you upload. You can skip entering details manually.  

De-clutter your business

Technology to the rescue again! Choose a software like Zoho Books to do the heavy lifting. Use automated workflows to send invoice reminders, get notified when a customer pays. Connect your bank accounts to auto-match receipts & payments with invoices. These will save a lot of time.

Separate your Business & Personal Expenses

Ancient wisdom says don’t mix business with pleasure. Therefore separate your business & personal expenses. For starters open a business bank account. Have all your business expenses & revenues in this account. You can always draw money from this account as salary or reimbursement. 

Make it a Habit

In between all the fun you are having, take some time out to do bookkeeping. Bring all your smartness to fore at least once a week. Check for vital signs like cash flow, unpaid invoices & vendor bills, payroll and taxes. 

“This is a very complicated case, Maude. You know, a lotta ins, a lotta outs, lotta what-have-yous.” — The Dude

Be the Dude and let Integra Books to do the heavy lifting. We will pair you with an expert and a software. 

(PS: If you are a hard-working, diligent person, we are sorry we wasted your time. Here is something for you too)

 

E Commerce Accounting 1.0- A must read

by Sanjeev Archak Sanjeev Archak No Comments

The internet is fueling the world economy. India is no exception. An enormous population, increasing smart phone penetration and cheap data rates make India a prime market for any  e-commerce business.  A report by Business Today states that Indian e-commerce business has reached $38.5 billion. But before you start up you need to figure out a business model,buy a software platform, have a logistics partner,  have a sales & marketing plan. However, do not forget to have an accounting plan in place. A online venture is a challenge to an accountant and the founder.  E-Commerce Accounting 1.0 is the prep lesson before you hit the ground running.

Choose an E-Commerce Platform

It all starts from having a tool for handling your entire online business. A e-commerce platform will enable you to:

  1. build your website
  2. catalog your products
  3. handle orders/invoicing
  4. connect with payment gateways
  5. manage your inventory

Some of the  popular tools are Shopify, Magneto & Zoho Commerce. These tools will help you set up an online store quickly with least effort.These tools have to integrate with books of accounts for recording sales, purchase transactions. We recommend Zoho Commerce for the automatic integration with Zoho Books. This integration will save critical man hours.

Payment Gateways

A majority of your customers will pay you online. Your customers will  make payments for purchases via a payment gateway. Your bank accounts will have to be integrated with payment gateways. There are multiple payment gateways to choose from like Razor Pay, PayU & PayPal. These gateways charge anywhere between 1.5% to 5% of the payment received as gateway charges. Further, they do not transfer amounts received instantly to the bank account. There is lag of 2-3 days before amounts are credited.

Moreover, a reconciliation has  to be done between the invoices raised and cash received  from the payment gateway. Your books of accounts must automate, partly if not fully, this process.

Manage Inventory

If you hold inventory, then opt for an inventory management tool. Always remember that unsold inventory blocks cash. Therefore, an inventory tool will give you an insight into fast,slow and non moving items. It makes sense to sell only fast moving items and stock slow moving only when there is a demand.For instance, offering discounts on slow moving items can unblock cash.  Zoho Inventory allows you manage the entire process from procurement to sale seamlessly. Re-order level can be set for all items of inventory. This will prevent you from selling items that you don’t have.

Handling Product Returns, Credits & Discounts

E-commerce business thrives on discounts, cash backs & other credits. All of these have a financial impact.  Seamless integration between the e-commerce store and accounts will help. As the number of transactions rise, discounts and returns are bound to increase. An accountant must be fed this information for tracking numbers. Financial insights from books of accounts can be used to calibrate business strategies. You can read our post on retail metrics here

Managing Logistics

This is the “last mile” for an online business. The most critical part of the business is on time delivery.  Delivery deadlines have to be met and measured as a KPI. Indians still prefer Cash on Delivery, which means the delivery  partners  have to collect cash as well. Secondly, the cash has to be deposited into your bank account. Typically, there is a 2 week gap between collection & deposit of cash. In other words, your logistics partner becomes your debtor as well.

An accounting software must support integrations with logistics partners. This is a must as cash is involved.

Comply with GST Rules

In addition to the above, you must abide by GST regulations. GST in India is complicated. Different rates of taxes apply to:

  1. sales between the states
  2. sales within  the state
  3. export sales
  4. warranties
  5. additional services tied to product sales

Therefore, all the tools of your business must combine to meet this regulation. For example Shopify or Zoho Commerce must apply GST rates based on the customer location. Further, inventory tool must apply GST on warehouse transfers. Similarly,materials sent out for job work must also be addressed. As transactions increase GST filing must get automated as well.

Final Thoughts

This post is the result of handling clients in the e-commerce space. Integra Books uses and implements all the Zoho products mentioned in this post.  The benefits of technology and automation can transform your business. Let Integra Books assist your online business. Get in touch!

Messed Up Accounting: Books Breaking Bad

by Sanjeev Archak Sanjeev Archak No Comments

We have given you a guide on effective accounting and setting up financial systems.  What if these guides are not followed? The result will be messed up accounting and a bad set of books. Here is a primer on how to identify mistakes in your books of accounts.

 Accounts not Reconciled

Bank accounts, credit card statements, inventory, debtors and creditor accounts have to be reconciled. If the accounts aren’t reconciled, it’s very likely that there are erroneous transactions or missing transactions. It is very important to reconcile the TDS & GST accounts. Left undone, these could lead to tax issues for the business.

High Accounts Receivable & Payable

Accounts receivables & payables are dynamic numbers. Old invoices need to be paid and the new ones marked as to be paid. If these two are static then your accountant is not marking money received or paid against invoices. This can lead to double counting of revenue & expenses. A customers & vendor balances report will throw up this anomaly.

Negative Inventory Balance

This means that you have sold products that you do not have. This can have an impact on your profits as well. If the negative balances add up over time, it takes huge efforts to bring it back to the current position.

Incorrect Capitalization

Another recurring problem we see is that accounts which need to be capitalized are not done and instead expense accounts end being capitalized. Missing out on capitalization will lead to lower depreciation claim and thereby higher taxes.

Payroll not booked correctly

Payroll is a significant cost for your business. This is an expense and a liability as well. Wages have to be paid to employees and payroll taxes to the Government.  A simple thumb rule is there must 12 entries in the payroll expense accounts and payroll taxes account must not have any balance. Variations from these norms mean that there is an error.

Inconsistent method of accounting

You must adopt either cash or accrual method of accounting. This often depends on the nature of the business. Once chosen, follow the method consistently. If you have switched between methods or have used a hybrid of these two will mess up the books.

Negative Balances in Accounts

Accounting is much more than arithmetic. Accounting rules do not permit negative balances in any account. If you spot negative balances then it is another case of bad bookkeeping.

Incorrect Capital Accounts 

Funding rounds raised by your company needs to show in the capital. The cap table is also derived from this account. Different categories of capital need to be shown separately. Further funding rounds could become complicated if all types of capital are lumped together.

 

So hire Integra Books to make your life easy. Integra Books is a modern and effective way of managing your business finances. We use a combination of technology and human expertise to make sure you get the best financial services for your business.

 

 

GST Changes: Input Credit Restriction

by Sanjeev Archak Sanjeev Archak No Comments

Another set of changes to GST law has been announced on 20.10.2019. This time the GST Council has decided to restrict the input credit available to tax payers. Consequently, input credit  in respect of invoices/ debit notes not uploaded by suppliers (i.e. not appearing in form GSTR-2A) cannot be availed in excess of 20% of the eligible ITC pertaining to invoices / debit notes uploaded by the suppliers. This input credit restriction is explained as an illustration below:

Particulars Actual ITC Eligible ITC after amendment
Input credit for Oct                       1000  
Input credit appearing in GST 2A 600  Rs 600 is available as credit
Input credit not appearing in GST 2A 400 Rs 120 (600*20%) or Rs 400 whichever is lower i.e, Rs 120 is available as credit
Total GST Input Credit   Rs 720

This amendment will create multiple problems for tax payers and tax professionals.Starting October 2019, all tax payers will have to reconcile the input credit as per books of accounts and GST 2A. Further, the differences between the two will have to be communicated to the vendors. This is essential to avail input credits.

How will this impact quarterly return filers?

As per the GST law, tax payers with an annual turnover of less than 1.5 crores have the option of filing GST 1 returns quarterly. If you are business filing monthly GST returns and your supplier is filing quarterly returns, then there is bound to be a input credit mismatch. This will lead to a situation where large businesses will stop buying from small vendors. 

How will the GST portal identify ineligible credits?

All manner of GST credits are reflected in the GST 2A. The GST portal does not have any facility to distinguish between credits which can and cannot be availed. This being the case using GST 2A as measure to avail input credit is not a good idea.

Is a return matching tool available to tax payers?

The new return structure is supposed to include a matching tool. However, the launch of this tool has been put off till April 2020. The absence of this tool means that tax payers will have to invest in resources and systems to do the reconciliation. Further, there is a time constraint as GST returns have to filed on the 11th and 20th of the month. Setting aside weekly off days and one day for tax payment, the tax payers have a small time window to match GST credits, reverse ineligible credits, re-avail reversed credits and compute tax payable.

How will this impact compliance costs? 

The GST has already increased compliance costs due to complicated returns schema and multitude of returns. GST law has been amended countless times since inception. Huge number of clarifications/notifications/ circulars have been released making matters even more complex. Further, this amendment also burdens tax professionals with more work prior to filing returns. This is bound to push up compliance costs.

Final Thoughts

The Government has not thought through this idea before implementation. There are basic errors in this idea which have not been addressed. Moreover, this idea does not address month end movement of goods i.e goods/services provided at the month end with invoices being raised,such goods/services received in the next month. There is bound to be input credit difference in this case as well. 

A business owner will now have to chase all his vendors for input credits. Are business owners supposed to run business or worry about paper work? Chasing vendors will take up a huge resources and effort. Entrepreneurs are supposed to create jobs and fuel the economy. They are not be burdened with compliance clutter. These amendments to the GST are law are wholly unnecessary.  

 

 

SaaS: How to Recognize Revenue

by Sanjeev Archak Sanjeev Archak No Comments

The SaaS business model provides some interesting challenges to both businesses and accountants.The SaaS industry has several metrics to measure growth. There are terms like Monthly Recurring Revenue, Average Revenue Per User, Annual Contract Value, all these have revenue in common.But these may not have any accounting relevance.How to recognize revenue for a Saas company?

Lets us understand some of these terms:

Annual Contract Value(ACV)

ACV is the total value of the contract agreed with the customer. This contract can be for a year or more. This also called a “booking”. Some SaaS companies include one time implementation or customization fees into “booking”. 

Annual Recurring Revenue(ARR)

ARR is the Annual Recurring Revenue from your customers. This the revenue you’d collect in the coming 12 months if you don’t add or churn anything. 

Monthly Recurring Revenue (MRR)

This is the ARR divided by 12 or you could say ARR is MRR times 12.

These terms do not have any relevance under GAAP or India Accounting Standards. How does an accountant view these terms?

Here is an example with multiple contracts being signed and going live on different dates:

  1st Contract 2nd Contract 3rd Contract 4th Contract 5th Contract
Contract Signed 1-Apr-19 1-May-19 1-May-19 1-Jun-19 30-Jun-19
Go Live Date 1-May-19 1-Jun-19 1-Jul-19 1-June-19 01-Jul-19
Term 12 months 12 months 12 months 12 months 12 months
ACV          1,20,000            1,20,000          1,20,000          1,20,000          1,20,000

Among the above contracts, only of them will recognized for as ARR viz, Contract 4. The revenue on the other contracts will be recognized as seen below:

  April May June July
ACV Bookings          1,20,000          2,40,000    1,20,000                    –  
ARR Booking          1,20,000          2,40,000    1,20,000                    –  
MRR Booking             10,000             20,000       20,000                    –  
Recognized ARR                       –            1,20,000    3,60,000       6,00,000
Recognized MRR                       –               10,000       30,000          50,000

As the CEO of an Enterprise SaaS company, make sure you understand if you are talking bookings or recognized revenue. Your bookkeeper should be able to help you out if you have questions.

A good accountant will recognize revenue when it is due and will help the revenue curve for the company. Revenue numbers have a huge influence on founders and investors. Therefore, make sure your ARR and MRR numbers are correct. 

Setting up Financial Systems

by Sanjeev Archak Sanjeev Archak No Comments

At Integra Books we have helped multiple clients raise capital from Angels and VC’s. Fund raising is an exhaustive process involving due diligence , pre & post funding compliance’s. Investors look at not only at the business prospects  but also at the financial systems in the  company. Consequently, having a few key things tied up and organized can make all the difference.  We have already given you a primer on making your accounting effective.  Here is a quick guide on setting up  financial systems.

Set up Books of Accounts

An ideal  accounting system reduces the time spent by the founders on record keeping, provides the investors and founders with profit & loss statements, cash flow and balance sheets. A software like Zoho Books integrates with whole range of applications like Zoho Payroll, Zoho People,Zoho Expense in the background so you can concentrate on running your business.

Track your Expenses

A business must track every rupee spent. A clean Profit & Loss statement makes the audit a smooth affair. Moreover, there are tax rules which have to be  complied with regards to expenses. Hence, a keeping a keen eye on expenses is critical. A tool like Zoho Expense  can completely digitize the process of expense management. Say goodbye to shoe boxes of receipts, further Zoho Expenses syncs with Zoho Books enabling automation.

Set up a Payroll System

Employees are the most critical component of your business. A properly structured payroll can be a win-win for the employees and the employer. A payroll system must ensure compliance with tax & labor law, ensure payment on time to employees. Here is where Zoho Payroll can automate the payroll process, create diverse pay structures and enable payment on time. Integration of Payroll with Books reduces a lot of manual work.

Stay Compliant with Laws

India is has many compliance’s to be met by businesses. Recently, India has moved up on Ease of Business rankings  but a lot more remains to be done. Non compliance can have grave consequences both founders and investors. Every business needs help to stay on top of compliance’s. At Integra Books, we have developed a Compliance Calendar which intimates our clients on compliance due dates.   

 Set up a Reporting System

Now that you have an accounting software integrated with other tools, its time to set up a reporting system. Investors mandate that financial reports be provided regularly. This report goes beyond P&L and Balance Sheets and must provide key metrics of your business. As founders,automating these reports will reduce both time and effort. We recommend Zoho Analytics.

Prepare for  Due Diligence

Due diligence is a precursor to funding. It is a test a business must pass before money can roll into the company. We have provided a due diligence check list here , the next venture round or sudden acquisition suitor always happens at the least convenient time, so make sure you’re prepared ahead of time!

Financial systems are required to take the business to the next level. Every business must leverage technology and automation to avoid chaos. As companies grow the burden of managing numbers and compliance’s always tend to fall on few shoulders. Moreover, logistical challenges around these can overpower any business. Early adoption of financial technology can reduces these challenges freeing up founders to run the business.

At Integra Books  we have helped many business’s transform their finance functions. Get in touch to transform your business.

 

Retail:Financial Metrics

by Sanjeev Archak Sanjeev Archak No Comments

Anyone with a business knows that the numbers don’t lie.Retail is a hyper-competitive industry. And, I promise, your competition is already tracking and measuring retail metrics.  Retail, in particular, is data rich with constant tracking on so many levels. A lot of business owners lose out as they do not know what to look for or if they do they struggle to find a way to bring the data together. Let’s get familiar with key financial  metrics for retail businesses.

Stock turn/inventory turnover

Also known as inventory turnover, stock turn is the number of times stock is sold through or used in a given time period.Stock is a huge part of your retail operation. So if you find yourself replenishing an item frequently that item has a high turnover. If you rarely need to order it then it has a low turnover. 

To buy stock, you need cash, once you buy the stock that money is then tied up in that product until it is sold. If something has a very low turn rate it means it reduces your cashflow and essentially ties up funds on your shelves. Figuring out the worst performing items and reducing your number of lines on that basis can improve your cashflow and boost your bottom line.

Gross margin

Every business needs to make a profit in order to survive.Gross margin is defined as: total sales revenue minus the cost of goods sold, divided by the total sales revenue, expressed as a percentage.Tracking Gross Margin ensures you are actually turning a profit.Having this information available  real-time as possible means you can act fast and avoid  losses 

Cashflow

Cash is king. A business cannot survive without cash.A retail business needs cash daily to keep the show running. If you are selling seasonal products then cash management becomes crucial in the off season. Track these trends and understanding when they will occur allows you to stay ahead . A cash forecast always helps you stay on top of your cash situation.

Average Transaction Value

All retail marketing efforts are directed towards attracting new customers. A retail business needs to find ways of increasing the customer spend over a period of time. An increase in 10% spend by a customer,across product lines can be huge.Tracking the average sales value and then finding ways to improve it is vital.The key is to increase the average sale value and add to your revenue.

What metrics do you find the most useful in your business?

 

Cash Basis Accounting vs. Accrual Accounting

by Sanjeev Archak Sanjeev Archak No Comments

In our previous post we have touched upon how to make your accounting effective. In this post we will explore ” Cash Basis Accounting vs Accrual Accounting” in detail.

The difference between cash and accrual accounting lies in the timing of when sales and purchases are recorded in your accounts.Cash accounting recognizes revenue and expenses only when money changes hands, but accrual accounting recognizes revenue when it’s earned, and expenses when they’re billed (but not paid).

Cash Basis of Accounting

Cash basis is simplest method of accounting.Revenues and expenses are accounted when they are paid.Consequently, this method does not recognize accounts receivable or payable.

This method is best suited for small businesses as it is easy to determine when the transaction has occurred.Moreover, there is no need to track receivables or payables. One has to look at the bank balances to understand the money available. 

Accrual basis accounting

Accrual accounting is a method of accounting where revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid. Revenue is recorded when the delivery of the product or service is complete, rather than waiting for payment.

Accrual method is an improvement over the cash method of accounting. This provides a realistic, long term view of the business finances. A possible downside is is that accrual accounting doesn’t provide any awareness of cash flow; a business can appear to be very profitable while in reality it has empty bank accounts.Accrual basis accounting without careful monitoring of cash flow can have potentially devastating consequences. 

The effect on cash flow

The method of accounting has an impact on the cash flow. Let’s look at an example of how cash and accrual accounting affect the bottom line differently.

Imagine you perform the following transactions in a month of business:

  1. Sent out an invoice  for Rs 5,000 for service completed this month
  2. Received a bill for Rs 1,000  in developer fees for work done this month
  3. Paid Rs 75 for a bill received last month
  4. Received Rs 1,000 from a client for a project that was invoiced last month

The effect on cash flow

  1. Using the cash basis method, the profit for this month would be Rs 925 (Rs 1,000 minus Rs 25)
  2. Using the accrual method, the profit for this month would be Rs 4,000 (Rs 5,000 minus Rs 1,000)

Which method to Choose?

The Income Tax Act in India allows non corporate entities to maintain books of accounts under cash basis. Non corporate entities in India may include an individual, a proprietary concern, a Hindu Undivided Family (HUF), a partnership firm, a LLP, a trust, etc.A corporate entity viz public & private limited companies, LLP’s are required to maintain the books of accounts only under accrual basis. 

A change in the method of accounting has to be stated in the income tax returns filed every year.