Cash Basis vs Accrual Basis: How Small Businesses Calculate Profit

Introduction

How does a small trader calculate business profit for tax purposes — does he record money coming in and going out when it actually happens (cash basis), or when rights and obligations arise (accrual basis)? This choice of accounting basis determines the income reported on the tax return.

This article explains the two accounting bases, who is allowed to prepare accounts on a cash basis under HASiL's guidance, an example cash book, and the record-keeping obligations that continue to apply.

Cash basis vs accrual basis — brief definitions

• Cash basis: report income when it is received and deduct expenses when they are paid.
• Accrual basis: report income and expenses when they accrue — that is, when a right or obligation arises, even if money has not yet been received/paid. This is standard financial statement practice.

HASiL states: "Accounts may be prepared on a cash basis where you may report income received and deduct expenses incurred for the relevant accounting period" (Record Keeping Guide, R1).

Small business threshold — who may use the cash basis

According to HASiL's Record Keeping Guide, a small business means a business whose gross turnover for a year does not exceed RM150,000 from sales of trading goods, or RM100,000 from the provision of services. A business within these limits may prepare accounts on a cash basis.

Example cash book from HASiL

The HASiL guide gives an example of simple records: a cash book for recording all receipts and payments (cash/cheque) together with profit and loss details, with monthly balances reconciled against bank statements. The examples used include a roti canai seller and a hairdresser — businesses most of whose transactions are in daily cash.

Record-keeping obligations remain

The choice of accounting basis does not remove the obligation to keep records:

• Business records/account books (including sole proprietors and partnerships) must be kept for 7 years.
• Failure to keep adequate records can lead to best-judgement assessment by the Director General and an offence under s.119A ACP 1967 (fine RM300 to RM10,000 / imprisonment up to 1 year).
• Business expenses are deductible if they are wholly and exclusively incurred in producing gross income (s.33(1) ACP 1967).

Note the difference: the cash basis for tax/account reporting is different from daily cash records. Records still need to be kept and reconciled.

Consistency of basis — and the risk of changing basis

One basis should be used consistently from one year to the next. For larger businesses, the accrual basis is commonly used — but the details of the statutory/accounting standard requirements and the rules for changing basis have not been confirmed in the probed sources; see the this item still awaits official confirmation from HASiL — check again with HASiL before deciding. notes below.

this item still awaits official confirmation from HASiL — check again with HASiL before deciding. notes from research

Frequently Asked Questions (FAQ)

Q. Can my small business use the cash basis? A. Yes — if annual gross turnover does not exceed RM150,000 from sales of trading goods or RM100,000 from services, you may prepare accounts on a cash basis (R1). This is an option, not an obligation.

Q. What is the difference between the cash basis and the accrual basis? A. The cash basis reports income when received and deducts expenses when paid; the accrual basis reports them when they accrue/obligations arise.

Q. Do I still have to keep records if I use the cash basis? A. Yes — records must be kept for 7 years; failure to keep adequate records can be an offence under s.119A ACP 1967.

Q. Can I switch from the cash basis to the accrual basis? A. The transition/change-of-basis rules have not been confirmed — this item still awaits official confirmation from HASiL — check again with HASiL before deciding. Use one basis consistently and verify with HASiL/a tax adviser.

Glossary

• Accrual basis — reports income/expenses when they accrue (a right or obligation arises), not when money changes hands.
• Cash basis — reports income when received and deducts expenses when paid.
• Cash book — a simple record of all receipts and payments, reconciled against bank statements.
• Gross turnover — total gross sales/receipts of a business before deductions.
• PYL (Pendapatan larasan) — adjusted business income.
• YA — Year of Assessment.