Bookkeeping News

Basis of Accounting Methods Part II

The most common basis of accounting methods include:

• Accrual or GAAP (Generally Accepted Accounting Principles)
• Cash
• Modified accrual or cash
• Tax

The following paragraphs discuss the bases of accounting commonly used and considerations for selecting each.

‍Accrual or GAAP (Generally Accepted Accounting Principles) Basis
‍Accrual or GAAP basis financial statements present the financial position (Balance Sheet) and results of operations (Statement of Income or Profit and Loss) in accordance with accounting principles generally accepted in the United States. GAAP basis financial statements are prepared using the accrual method.

Under the accrual method of accounting, assets, liabilities, equity, revenues, and expenses are recorded when they are earned or incurred, which may or may not coincide with the time cash is received or paid. Few small to medium-sized businesses are required to prepare GAAP financial statements on a regular basis. However, some may occasionally prepare GAAP financial statements if, for example, they are required to do so by creditors.

The accrual basis of accounting is a method of accounting in which transactions are recorded when earned. For example, under the accrual basis of accounting, a company that sells a product in December of 2024 but receives the cash proceeds from the sale in January of 2025 would record the sale in December of 2024 when the revenue was earned (Accounts Receivable or A/R).

Other Comprehensive Basis of Accounting (OCBOA)
‍The financial statements of many small to medium-sized businesses are prepared in conformity with other comprehensive basis of accounting other than accrual or GAAP basis financial statements.

The most common presentations are summarized below.

Cash Basis
‍Only cash receipts and disbursements are recorded, and no transactions are capitalized. Financial statements presented on a pure cash basis essentially present a summary of receipts and disbursements and reconcile beginning and ending cash.

The cash basis of accounting is a method of accounting in which transactions are recorded only when cash is collected or paid. For example, under the cash basis of accounting, a company that sells a product in December of 2024 but receives the cash proceeds from the sale in January of 2025 would record the sale in January of 2025 when the cash proceeds were paid.

Modified Cash or Accrual Basis
‍Substantially all transactions recognized are cash receipts and disbursements. However, some noncash transactions may be recognized, such as accounts receivable or accounts payable, and some transactions are capitalized and amortized following accrual requirements. For example, capital expenditures may be recorded as fixed assets and depreciated following accrual guidelines.

Tax Basis of Accounting
‍How transactions are recorded, such as whether amounts are capitalized, depends entirely on tax regulations. Therefore, the cash or accrual method could be used depending on the basis of accounting the reporting entity uses, or expects to use, to file its income tax return for the period covered by the financial statements.

The tax basis eliminates the need for converting from one basis for bookkeeping purposes to another for tax reporting. When the income tax accrual basis is used or the income tax cash basis supplemented with appropriate accrual basis information such as accounts receivable and accounts payable, income tax basis statements are meaningful management tools. In addition, they are often easier for non-accountants to understand and use than accrual financial statements.