How to allocate costs and revenues using the cash principle
The cash principle is of fundamental importance for tax returns and the calculation of taxable income. In fact, it is a tool for managing receipts and payments for allocation in the balance sheet.
But what is it and how does this accounting principle work? Let's find out together in this article!
What is the cash principle?
The cash regime or cash principle is a criterion for allocating costs and revenues in the financial statements. The purpose of the cash principle is to allow the determination of taxable income.
The special feature of the cash principle is that only costs and revenues collected or paid during a reporting period (corresponding to the calendar year) are allocated. In other words, according to the cash principle, only those entries are imputed which have undergone a financial manifestation during the same financial year.
For example, the cash principle only includes in the calculation of income those invoices that have resulted in a demonstrable movement of money by 31 December of the year under consideration.
Cash principle vs. accrual principle
The cash principle differs from the accrual principle with regard to the type of expenses and revenues to be recognised in the financial statements. In fact:
→ the accrual principle determines the obligation to record transactions in the tax period in which they occur, regardless of whether financial events are paid for them.
→ the cash principle, on the other hand, provides for the obligation to record only transactions relating to the tax period in which they occurred, regardless of whether financial events are paid for them.
For anyone applying the accrual principle, the tax period that includes the date on which the transaction of the money occurred applies. This may correspond to:
- The delivery or dispatch for movable goods;
- The signing of the contract for immovable goods;
- The accrual of consideration for services.
For anyone using the cash principle, however, the tax period that includes the time of actual receipt applies. Revenue already collected may be a consequence of:
- Payments in cash: in this case, no problem arises as to the date on which the transaction begins to be valid, because the remuneration reaches the recipient when the money is transferred.
- Payments by cheque, bank transfer, credit or debit card: the date on which the money is available on the account and can be used becomes valid.
Who can adopt the cash principle?
Accounting requirements and obligations
As a rule, the cash principle is adopted by accountants under the simplified accounting regime, but all business entities that
- They are active in business, arts or professions;
- Had a turnover not exceeding EUR 2 million in the previous year.
👀 In the case of business start-ups, something subjects expect to achieve a turnover not exceeding EUR 2 million.
- They carry out taxable supplies of goods or services to purchasers or customers in the territory of the State who are themselves engaged in the exercise of their trade, business or profession.
☝ The new Budget Law introduced the possibility of applying the cash principle by artisans, traders and, in general, all small VAT accounts in simplified accounting.
→ The application of the cash principle is also permitted for smaller businesses via integrated VAT registers.
In this case, however, it is necessary to record income and expenditure accompanied by the respective invoices issued. In addition, it is mandatory to record out-of-pocket expenses and invoices that have not yet been paid. This case of application also requires the recording of transactions relating to invoices that have not yet been raised.
👀 Information on income and expenses is entered in the VAT registers for the tax period in which the receipts and payments occur.
So-called one-person businesses may also adopt the cash principle:
- Sole proprietorships or self-employed persons with VAT registration,
- Commercial entities,
- partnerships
which are subject to certain turnover limits, i.e:
- EUR 400,000 for businesses that provide services;
- EUR 700,000 for companies carrying out other activities.
The obligations take the form of three alternatives as regards the registers to be kept:
- Registers of receipts and payments;
- VAT registers only.
👀 In this case, it is necessary to make a separate entry with the details of transactions that are not subject to registration for VAT purposes.
- Only VAT registers with presumption of receipt and payment.
👀 In this case it is possible to avoid the entries concerning payments and receipts, but it is necessary to enter the transactions not subject to registration for VAT purposes.
Cash principle: does it pay off?
The cash principle may be more advantageous than the accrual principle, but why? Well, as we have seen, the cash principle allows only costs and revenues that have had an actual financial manifestation within the financial year, i.e. in the calendar year of reference, to be booked.
In this way, only those costs and revenues are taken into account that have actually been the subject of cash receipts or disbursements, i.e. transactions in the tax period. This leads to an important simplification in the financial statements.
The cash principle is, in practice, convenient for anyone who has a business activity that enables him or her to make immediate cash receipts, e.g. restaurant activities, retail shops and boutiques, as well as activities involving progressive payment to suppliers.
Article translated from Italian