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In this article, I provide information about various special purpose reporting frameworks (e.g., cash basis, modified-cash basis, and income tax basis) and how you can use them to create financial statements for your clients.
Suppose you’ve been contacted by your client to prepare their financial statements and issue a compilation report. At first, you think, I’ll create the financials in accordance with GAAP, but then you remember there are special purpose reporting frameworks. Maybe the cash basis or income tax basis is a better option.
What is a special purpose reporting framework? It is a reporting framework other than generally accepted accounting principles (GAAP) that is one of the following:
Let’s begin our exploration of special purpose reporting frameworks by examining the simplest one: the cash basis.
While a pure cash basis financial statement is the easiest to create, it may be too simple. After all, you only create one financial statement. Here’s an example cash basis financial statement:
|Total Disbursements||$ 94,000|
|Increase in Cash||$106,000|
Notice there are no accruals and no balance sheet in this example cash basis financial statement. When the company spends and receives cash, the transaction is recorded; otherwise, there is no entry. So who might benefit from the pure cash basis? The cash basis might be useful for a small nonprofit, a trust, or a student activity fund.
If the cash basis is not an appropriate solution, then consider another special purpose reporting framework: the modified cash basis.
Using the modified cash basis, you can present a balance sheet, an income statement, and a cash flow statement. It is, however, permissible to create just one statement–such as the income statement–and issue a compilation report. If you present a balance sheet and an income statement, the cash flow statement is optional.
The Statement on Standards for Accounting and Review Services (SSARS) defines cash basis as a basis of accounting that the entity uses to record cash receipts and disbursements and modifications of the cash basis having substantial support (for example, recording depreciation on fixed assets). So we see that modifications to the cash basis are permissible under SSARS.
A modification to the cash basis is considered to have substantial support if it is equivalent to GAAP and is not illogical. And what is an example of an illogical modification? A balance sheet with accrued receivables but no accrued liabilities. Such a presentation makes a company appear stronger than it is. Moreover, it doesn’t make sense to accrue an asset and not accrue a liability.
So how does the modified cash basis differ from the cash basis? Using the modified cash basis, you can record an item on a balance sheet when the transaction involves cash. So if a company loans cash to an outside party, a loan receivable could be recorded on the balance sheet. (If the cash basis is used, the loan is reflected as a disbursement.) The accounting entry for the loan is as follows:
Loans Receivable XX
Since cash is a part of the entry, it is okay to record the loan on the balance sheet using the modified cash basis.
But if a company sells inventory on credit it would not record the transaction. Why? No cash is involved in the transaction. The same is true of payables: they are not booked since cash is not a part of the entry. If the company did accrue payables for supplies, the entry would appear as follows:
Supplies Expense XX
Accounts Payable XX
But because cash is not a part of the entry, it is not made when the modified cash basis of accounting is used.
By contrast, when a company pays cash for inventory or plant, property, and equipment, then those assets can be reflected on the balance sheet. (Also, plant, property, and equipment can be depreciated.) The same is true when the company obtains a loan: cash is received, so the debt can be recorded on the balance sheet.
What are examples of non-cash transactions that should not be recorded using the modified cash basis? Here are a few:
So, it’s obvious that these non-cash transactions don’t qualify for use in modified-cash basis financial statements. But some cash-related transactions might also be omitted.
The modifications to the cash basis are not defined in auditing or SSARS standards. In other words, there is judgment in selecting the modifications to be used. So even transactions involving cash might not be recorded. One person preparing modified cash basis financial statements might do so differently than another. Why? Because they are using different modifications.
If this makes you uneasy, the tax basis of accounting might be a better option.
In using the tax-basis of accounting, the transaction recognition criteria is simpler than that of the modified cash basis of accounting. Just ask, Is this transaction recognized on the tax return?
So what income tax basis financial statements can be presented? You can present just one financial statement (e.g., balance sheet), or you can present the balance sheet (referred to as the statement of assets, liabilities, and equity-tax basis) and the income statement (statement of revenues and expenses-tax basis). A cash flow statement is optional: you can include one or not.
And what entities can use the tax basis of accounting? Any entity that files a return with the IRS, including an income tax return or an information return. So a nonprofit that pays no taxes and files a 990 can use the tax basis of accounting, but a government that files no return can not.
Example entities that use the income tax basis of accounting include:
If you prepare a tax return for a client, then the tax basis is the most efficient way to deliver financials.
Special purpose reporting frameworks provide certain advantages including:
Are there reference guides for special purpose reporting frameworks? Yes.
Guidelines for Cash- and Tax-Basis Financial Statements — AICPA — Free and Downloadable
Cash, Tax and Other Bases of Accounting — Thomson Reuters
The Thomson Reuters guide has several sample statements and checklists.
Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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