I just sent out my monthly Lender’s Q&A answering this question from a lender:
“Why are tax returns and financial statements for the same year sometimes so different?”
{If you want info on (or to sign-up for) our Lender’s Q&A ezine, go to www.LindaKeithCPA.com or call Kimberly @ 360-455-1569}
There are legitimate differences between tax return and financial statement presentation of the same underlying facts.
- The tax return may be a different fiscal year (12 month period) than the financial statements.
- The tax return may be on the cash basis while the financial statement may be on the accrual basis. (See accrual basis in the index of your manuals for the detailed explanation.) To the extent that receivables or payables are significantly different from the beginning of the year to the end, the accrual basis may give a very different picture than the cash basis.
- There are differences in rules for tax returns and financial statements if the financials are done according to GAAP (Generally Accepted Accounting Principles). For example: The business can write off up to $108,000 of the cost of most equipment through depreciation in the year purchased for tax purposes (called Section 179) but has to write the cost off over the useful life of the asset for GAAP financial statements.
- The borrower may have used different estimates for the tax return to minimize taxes or defer them to a later date by selecting estimates or elections that are beneficial. LIFO versus FIFO inventory, selection of useful life for depreciation, or even straight-line versus accelerated depreciation methods are good examples.
So, should you worry about it? No. But if the differences are significant, see if you can tie it down to one of the factors listed above. If not, you might want to run it by a more experienced lender first…and then ask the borrower to help you understand the differences.
I stay away from ‘selling’ on my blog, and at the same time do not want to deprive you of resources, even if they are mine. If you need some help with cash versus accrual and the difference it can make, take a look at the self-study Financial Statement Manual at our website.
