What are the substantial differences between GAAP accounting and income tax basis accounting? Is income tax basis accounting synonymous with cash basis? We see a lot of statements compiled or reviewed on an income tax basis and I am wondering what we are missing.
Wouldn’t it be great if we just pick something and stick with it? Nah, that would be too easy. Actually, it just wouldn’t fit the needs of business.
Income tax basis is considered an OCBA (Other Comprehensive Basis of Accounting) and is very common fo small- to medium- size business.
Why the difference?When an accountant is primarily preparing the financial statements in order to prepare a tax return, why do GAAP? It is extra work and the client may not want or even need it. Picture a small business in which the owner is integrally involved in all phases of the business and does not need the more comprehensive GAAP-based statements to do a good job running the business.
What’s the difference? When using the tax basis of accounting, as an example, depreciation will follow tax rules instead of GAAP. Same with inventory.
GAAP vs Tax and Cash vs AccrualTax basis can be cash-basis or accrual-basis. So look for a label to tell you the basis. Or if you have the balance sheet any of these indicate accrual basis: Accounts Receivable or Prepaid Expenses in the Asset and Accounts Payable or Deferred Revenue in the Liabilities. Also Bad Debts on the Income Statement.
Cash flow calculationsWhile you don’t get quite the same sense of the business with tax basis as with GAAP accounting, you can still do a pretty good cashflow calculation by adding back depreciation and interest expense, determing debt payments and putting them on your list, and scanning for income or expense items that are out of whack for the size and type of business or compared to a prior year.
Need more on Cash vs Accrual basis? I recommend (of course!!!) our eCourse at www.LendersOnlineTraining.com on Cash versus Accrual Basis (16:20 minutes)
- Understand the difference between Cash and Accrual basis
- The impact on your impression of your borrower’s business
- How you can tell which was used
- Which is best for the business