Freelancer – Cash Basis or Accrual Basis of Accounting?

Income-tax law requires you to maintain books of accounts if your income/turnover exceeds limits as mentioned in Section 44AA. You must be wondering if I will be required to maintain books of accounts if my only source of income is from Salary. In that case, you will not be required to maintain books of accounts. You will not be required to maintain books of accounts also if you have income from house property or income from capital gains. The question of keeping books of accounts arises only when you have income from a business/ profession or income from other sources.

You must have heard about two systems of accounting, i.e., cash system (where entries are recorded only when the cash is received or cash is paid) and mercantile system (where entries are recorded basis of the income earned or expenses are incurred irrespective of whether actual payment has been made or not)

Once we know what Income and expenses are, we have to decide how to account for them. Should we account for Income when it is due to be received OR when it is actually received? Should we account for expenses when they are due to be paid OR when we actually pay them? The taxability of the income/deductibility of the expense depends on the method of accounting that you follow. 

As a freelancer, you need to choose between one of the 2 methods of accounting

• Cash Basis of Accounting
• Accrual Basis of Accounting (also called Mercantile Basis)

Differences between both the methods of accounting are as under:

Note that the accounting method you choose will have to be followed for all clients, all revenues as well all expenses. It may appear that by using Cash basis of accounting you tax liability will be reduced.

However, the reality is – it may only postpone your tax outgo, you will not be able to achieve a tax reduction as such. Once you choose a method of accounting you are expected to regularly comply with that method. You are not allowed to change the method of accounting often – if your intention is to save taxes or avoid taxes. Usually, it seems more logical to follow the Accrual Basis – unless your receipts are very irregular or are very uncertain.

However, for the taxpayers to whom the provisions of tax audit are applicable will be required to maintain their books of accounts in mercantile basis only.

Keep following a series of posts on Freelancers, which will be coming up shortly! We support Tax Filing for Freelancers and can take care of everything for you?  

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