Tips to understand your accounts and tax return
Everyone carrying out private practice should be preparing accounts and a tax return but the figures can be daunting to understand. But ultimately you are responsible for what is submitted to the tax inspector so it is important you understand them.
Private practice accounts
These are a record of financial performance and are prepared up to a financial year end. This may be in line with with the tax year end for individuals of 5 April (more commonly 31 March in practice) but could be any date during the calendar year.
Sometimes, there are cash flow advantages to adopting a financial year end that does not coincide with the tax year end but your accountant should discuss this with you.
The records kept by the business are extremely important to ensure that complete and accurate records are being maintained. Your accountant does not ‘audit’ your figures but should be bringing to your attention any deficiencies or problems they come across.
Annually, your accountant will ask you to submit your records and as a minimum they will produce a summary of income and expenses but for companies and larger practices, a balance sheet will also be prepared.
The balance sheet is an important part of the accounts production process and its inclusion is generally accepted as reducing your risk of an HM Revenue and Customs (HMRC) inquiry.
Additionally, there are often notes to the accounts which can provide further analysis of certain categories or provide additional information.
For companies and limited liability partnerships, the format of the accounts is prescribed under the Companies Act. For sole traders and other partnerships the format is more flexible but for both companies and the self-employed, there are accounting standards which govern how accounts are prepared.
Accountants should follow these standards as a matter of course but unfortunately anyone can call themselves an accountant so it is important you choose someone regulated by a professional body. Ensuring you accountant is suitably qualified ensures they have the training, expertise and are accountable for their work and ethics.
Income and expenses account
This can also be referred to as a profit and loss account and is basically a summary of your income and expenses the net of which is your profit for the financial year.
Note that your accounting net profit may be different to your taxable profit so if you are looking to match up the figures between your private practice and tax return, the figures may be quite different.
The main reason for this is that certain expenses are not ‘tax deductible’ and this means that despite them being recorded as an expense in your accounts, they must be added back when calculating taxable profit. For most consultants, these costs will relate to depreciation and legal fees.
Depreciation is an accounting term and is basically writing off the cost of an asset e.g. computer equipment over a period rather than in one go. A typical depreciation policy for a computer would be three years resulting in 1/3rd of the cost being included for three years.
The tax position is different as you are given capital allowances for purchasing most assets and at present you have a generous allowance of £1m to encourage capital investment in businesses.
This would be an example of why your accounting profit may be higher than taxable profit in the year an asset was bought but lower than taxable profit in subsequent years. This is because the annual investment allowance is effectively accelerated tax relief into the year of purchase which reduces that year’s taxable profit accordingly.
Costs such as legal fees have special treatment as certain costs are not deductible against your trading profits. Such legal costs would not be tax deductible even though they may be shown as an expense in the accounts. This would be another example of why your taxable profit may be higher than your accounting profit.
Tips for reviewing income and expenditure
The key thing to consider is whether the figures look reasonable against your expectations. If the accounting records are high quality, there should be less room for error.
But if the records are fragmented and perhaps mixed with personal income and expenses, it can lead to error or omission. It is recommended to run your private practice through a separate bank account and for companies this is the only option.
The first way to review accounts is to compare to the prior year to see if an expense looks reasonable compared to the year before and your expectations. Many costs rise proportionately with income but others may not track in the same way.
When looking at expenses that have been incurred during the year, consider the timing of payments when reviewing costs as an expense incurred covering a period after the year end is likely to be prepaid into the next period.
Income disclosure or revenue recognition as accountants call it is an important aspect to consider. It may seem unfair to have to disclose income that was not paid to you before your financial year end but for most this is the only option.
For clinical work this is not usually a problem as you will be paid well in advance of making any tax payments on that income but for medico-legal you may well be paying the tax in advance of being paid.
For small self-employed businesses where income is less than the VAT registration threshold, £85,000 as I write, you can account for income and expenses on a cash basis. But the transition to an earnings basis can be problematic so the advice generally is to use the earnings basis from the start.
For companies, the cash basis for disclosing income and expenses is not possible at any income level.
As mentioned previously, it is common for your taxable profit per your private practice accounts to differ to the figures reported on the tax return.
Your accountant should provide a tax computation indicating the key components of the tax return and give information about your individual circumstances. Any estimates or items requiring your consideration should be brought to your attention.
The pension annual allowance information has frequently been unavailable at the time of preparing the personal tax return and therefore as a minimum your accountant should be able to estimate your position and advise you.
Many tax returns need to be amended following the receipt of your actual pension growth figures so do not be surprised if you receive a revised tax return from your accountant.
Understanding your private practice accounts and tax return is important to ensure you are comfortable with the figures being disclosed to HMRC. It can take some time to obtain a thorough understanding so make sure you meet with your accountant periodically to go through things you are unsure of.
Ian Tongue is a partner at Sandison Easson specialist medical accountants