How to Understand Special Purpose Accounting Frameworks: Three Videos
In this post, I provide three videos explaining these bases of accounting: (1) cash basis, (2) modified cash basis, and (3) tax basis. These are known as special purpose frameworks.
Generally accepted accounting principles (GAAP) can be overly complex for small entities. For example, lease accounting can require a great deal of time. Another example of complexity in GAAP is revenue recognition using ASC 606. Some companies may want to consider a more straightforward basis of accounting.
Below, I tell you about three alternative bases of accounting.
1. Cash Basis of Accounting
The simplest accounting basis is the cash basis, so we start with this one. This is our first example of a special purpose framework. Here’s the video.
2. Modified Cash Basis of Accounting
The cash basis of accounting results in one asset on the balance sheet: cash. Some entities desire recognition of additional assets and liabilities. The modified cash basis of accounting–our second special purpose framework–allows companies to recognize certain assets and liabilities on their balance sheet. In this video, I explain what assets and liabilities can be included.
3. Tax Basis of Accounting
If your organization has a corporate or nonprofit tax return prepared, the tax basis of accounting–our third special purpose framework–may be your best option in creating financial statements. Some believe this is the most efficient way to create financial statements. Here’s a video that explains this basis of accounting.
Alternatives to GAAP
No one basis of accounting works for every entity. So, you need to consider which special purpose framework is best for you. Each alternative has its own pros and cons. But one thing is for sure: these alternative bases of accounting are usually less complex and, consequently, less time-consuming than GAAP.
One word of warning: Make sure GAAP is not required by laws, regulations, or legal agreements such as loan documents. If GAAP is required, these alternative bases of accounting would not work for your entity.
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Yes, the cash basis is usually used for small entities or activities. I think of band or football boosters. But larger entities could also use it such as governments or nonprofits, if there is no GAAP requirement. It all depends on the needs of the financial statement readers. If all they need is the cash amounts received and paid out, then the cash basis works. If they need a balance sheet with accruals, then it does not.
When I imagine pure cash basis accounting, I’m imagining a parent organization running a concession stand at high school events. What kinds of companies could function with such limited accounting information?
saves a lot of peer review problems for small firms
Yes, I agree. Those are better terms for cash basis.
Eddie, the financial statement (and there is usually just one) is a summary of receipts by category (e.g., sales) and disbursements by category (e.g., salaries), then a net amount (receipts minus disbursements), next the beginning cash balance, and finally the ending cash balance. I’ve never seen anyone present a balance sheet for cash basis, but if they did, it would be cash and equity (cash=equity) and that would be all—but there is really no value in a statement like this. Hope you are doing well.
I agree, Jim. Better to use a simpler basis of accounting and get the work done! And many smaller entities don’t need accrual-based records.
Hi Charles – another aspect of cash basis – it can be a small way to deal with the shortage of accounting talent. Sometimes better to be done correctly on the cash basis, then to spend time recording accruals, and then the auditor having to test the accruals. Obviously not appropriate for some entities, but something to consider.
My 2 cents – yes, all inflows would be “revenues” – but should probably called “receipts”, and the expenditures would be called “disbursements”.
Charles,
Thanks for these videos. In pure cash basis accounting, what is the other side of the journal entries when transactions are recorded? Are all inflows called revenues and outflows called expenditures, or is there another terminology specific to cash basis?