GAAP Verses Other Bases Essay Example

applied to all materials in the financial statements, such as the price-level basis of accounting (McEachern 2005). OCBOA financial statements offer an alternative to GAAP-based statements and are often chosen because they tend to be cheaper. Tax-basis financial statements contribute to cost cutting as they use the same information as tax returns. Cash-basis statements are also cheaper because they do not require the level of detail necessary for GAAP compliance. The main challenge lies in determining the appropriateness of these statements for the entity's nature. The AICPA PAS document identifies the characteristics of entities that may consider issuing tax-basis or cash-basis financial statements (Ratcliffe 2003). The cost savings associated with OCBOA statements mainly come from using simpler measurement principles, such as modified cash and cash-basis statements, or by incorporating measurement principles already used in other documents, like a tax return, during the preparation of the financial statements.Although cost savings from disclosure requirements are limited due to parallel requirements for both GAAP-based and OCBOA-based statements, the issuance of Auditing Interpretation No.14 has provided greater disclosure advantages for OCBOA financial statements compared to previous practices (Ratcliffe 2003). Regardless of whether the OCBOA financial statements are compiled, reviewed, or audited, the disclosure requirements remain largely similar. The SAS No.62 outlines similar disclosure requirements for audited OCBOA financial statements as well as reviewed or compiled OCBOA financial statements. However, practitioners must still understand the disclosure requirements under GAAP in order to ensure compliance with financial reporting requirements. This means that the substance of GAAP disclosures should be communicated in the disclosure made for OCBOA financial statements (Ratcliffe 2003). Practitioners note that OCBOA statements become simpler when they exclude certain

items, transactions, and events typically included in GAAP statements. For example, tax-basis statements do not include deferred taxes and therefore do not require the tax disclosures mandated by GAAP-basis statements.However, practitioners do not typically benefit from disclosing their review or compilation of OCBOA statements compared to auditing them. The advantage comes from using a different accounting basis for preparing the financial statements, rather than the level of service provided. Third-party users can pose obstacles to using the OCBOA method, but providing additional information beyond the basic financial statement can help persuade them to accept it. For example, if a partnership borrows money based on its accounts receivable, the lender may accept tax-basis financials if the partnership also provides a list of aged accounts receivable. The pure cash basis of accounting only includes transactions that increase the entity's cash and cash equivalent in the financial disbursements. Expenses are recognized as cash disbursements, while revenue is recognized as cash receipts. This basis is uncommon in practice and is typically used by non-profit organizations with simple operations and unsophisticated finance and accounting functions.and have minimal activity or are in their early stages of operations. Examples of companies that may use the income tax basis include start-ups, small businesses, and sole proprietorships (Grice 2003).Partnerships that are required by their partnership agreements to use the tax-based accounting method can issue OCBOA financial statements. Not-for-profit organizations seeking relief from the requirements of FAS-116 and FAS-117 can also issue OCBOA financial statements (Grice 2003).

Before deciding whether to use an OCBOA, the practitioner must consider various factors. If an entity maintains inventory, pure cash-based accounting is not suitable. The accounting basis used for

income tax preparation should be consistent. When entities have significant levels of debt, lenders may require GAAP financial statements. GAAP financial statements are typically necessary when there are outside investors who require specific information. Pure cash basis is appropriate when an entity's cash flow aligns with its income and expenses. Entities planning to go public will need a history of GAAP financial statements. For entities formed for tax purposes, the owner's main interest is the tax effects on transactions, making the income tax basis most appropriate. Additionally, entities subject to bonding requirements must provide GAAP financial statements (Madray 2006).

Any entity that is not obligated, either through a contract or otherwise, to prepare GAAP financial statements can issue OCBOA financial statements.When deciding to use OCBOA financial statements, an entity must meet certain conditions. Both external and internal users of the financial statements should understand and find them relevant to their needs. The preparation of OCBOA financial statements is cost-effective. Additionally, the entity's operations must be conducive for presenting OCBOA. The AICPA offers a non-authoritative practice aid that outlines considerations and characteristics for entities wishing to issue tax- and cash-based financial statements.

When considering the needs of third-party users, this includes entities without third-party users of their financial statements, such as small closely-held companies without third-party debt. It also includes entities with secured debt instead of unsecured debt and entities where GAAP financial statements are not required by creditors.

When considering the needs of managers and owners, the entity's owners and managers should be actively involved in the day-to-day operations and have a clear understanding of the entity's financial position. Owners primarily focus on cash flows, such as a

professional corporation of lawyers distributing cash-based earnings through retirement plan contributions, bonuses, and salaries. They may also be concerned with the tax implications of transactions.There are multiple factors to consider when determining the suitability of OCBOA financial statements. If the cost of complying with GAAP exceeds the benefits for the entity, it may not be necessary. Additionally, if the entity is not required to prepare tax returns using the accrual accounting method, it may not need to provide OCBOA financial statements.

In terms of operational considerations, long-term financing and capital expenditures should not have a significant impact on the entity. The decision to issue OCBOA financial statements is largely dependent on the needs of financial statement users. However, if providing these statements would be misleading, they should not be provided.

Various guidelines are in place to prevent misleading information in OCBOA financial statements. Practitioners are expected to apply the same criteria used in preparing GAAP-conforming statements to OCBOA statements. The practitioner's opinion should be based on judgment regarding whether the OCBOA financial statements, including related notes, effectively address their purpose and are easily interpreted and understood.

Accountants generally view OCBOA as inappropriate and misleading under certain circumstances. For example, if an entity has significant unfunded commitments, obligations, or contingent liabilities, they would not be reflected in tax or cash-based statements and would not provide a clear financial picture of the entity. (Madray 2006)The cash-basis does not indicate when an entity has postponed payment of outstanding liabilities, like accounts basis. Additionally, if financial statements exclude significant disclosures, it can be misleading. In conclusion, there is a growing popularity in using OCBOA financial statements. This is because practitioners are seeking

feasible alternatives to the complexity of preparing GAAP-basis statements. OCBOA financial statements are more comprehensible and cost-effective for clients. As regulations evolve, such as the increased requirements for GAAP reporting, it is evident that OCBOA statements will gain even more popularity among users and preparers of financial statements.