Understand what is meant by accounting period in tax and accounting, how to choose one and what happens if you decide you’d like to change your accounting period. Plus, I’ve included an example of an accounting period to help you understand fully what’s involved.
Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.
Table of contents
1. What is an Accounting Period?
An accounting period means the start date and end date used when preparing accounts and tax returns. Normally, accounts are prepared for a 12 month period, to the same date each year (unless it is their first year or last year of trading). Business owners can choose any start and end date they like for their accounting period, but when it comes to those registered as self employed, there are some things they may want to consider to avoid complications and inflated tax bills.
2. Example of an Accounting Period
Penny chooses an accounting period end date of 31 March. When she fills in her tax return for 2020/2021 she’ll need to declare her business income and expenses for the 12 month period 1 April 2020 to 31 March 2020.
3. Basis Periods
Sole traders can choose any period they like but going for something that doesn’t match the tax year can have tax implications because of HMRC basis periods.
To keep the tax system fair and stop people from playing the rules to reduce their tax bill, HMRC uses what is known as basis periods for working out how much tax a self-employed person owes. HMRC will use profits made during a tax year regardless of the accounting period an individual chooses, and it means profits can be taxed twice in their first year of going self-employed, resulting in a larger tax bill.
4. How to Choose an Accounting Period as a Sole Trader
Every year sole traders need to fill in a tax return, entering their total business income and expenses. Normally this would be 12 months income and expense, which would most likely come from an income and expenditure statement. Sole traders can choose any accounting date they like, but that can have tax implications.
There are times when an accounting period for a sole trader is less than 12 months. The most common reasons for this are:
- If a person has become self-employed during the tax year;
- A sole trader decides to stop self-employment.
The simplest option for the self-employed and sole traders is to choose an accounting date to match the tax year. But to make reporting easier, HMRC considers the 1 April to 31 March to be the same as the tax year.
5. How to Change Accounting Date as a Sole Trader
Sole traders can change their accounting period but will need to let HMRC know about this change when they fill in their tax return. A reason for the change must also be provided so that HMRC can review why a period wants to make the change and agree to it (or not). In addition keep in mind that:
- the first accounts for the new accounting date, must not be more than 18 months
- if a previous change in accounting date occurred in any of the previous 5 tax years, HMRC must be given a valid reason for the change. Changes can’t be made to gain a tax advantage so any changes must for genuine business reasons.
Again, sole traders should beware of the rules of HMRC basis periods because changing an accounting period can result in overlap profits because tax bills are always calculated based on the tax year. Although any overpayments can usually be repaid when stopping self-employment.