| EXECUTIVE
SUMMARY |
 IN CERTAIN INSTANCES CPAs
SHOULD CONSIDER preparing and
reporting on financial statements using an
“other comprehensive basis of accounting”
(OCBOA). Tax-basis and cash-basis,
including modified-cash-basis, financial
statements are the most widely used OCBOA
statements.
A MAJOR ADVANTAGE OF
OCBOA STATEMENTS is that many
clients and external users understand
them better than GAAP-basis statements.
In addition, OCBOA statements may cost
less to prepare compared with GAAP-basis
ones: It’s not uncommon to save clients
up to 20% to 30% in time and cost.
ONE OF THE ISSUES CPAs
FACE WITH OCBOA STATEMENTS is
the adequacy of disclosures within them.
A statement of cash flows is not
required, but statement titles should
clearly indicate the basis of accounting
the practitioner used. The notes to the
statements should include disclosures
related to contingent liabilities,
going-concern considerations and risks
and uncertainties.
SAS NO. 62 CONTAINS
REPORTING GUIDANCE FOR WHEN a
client engages a practitioner to audit
OCBOA financial statements. CPAs
typically will need to make certain
modifications to the standard audit
report when using it to report on OCBOA
statements.
WITH THE GROWING
COMPLEXITY OF PREPARING GAAP
-based financial statements,
the use of an OCBOA may be a logical
alternative that meets the needs of both
the client and the external statement
users. Recent regulatory changes also
may lead to an increase in the growing
popularity of OCBOA statements.
| | THOMAS A.
RATCLIFFE, CPA, PhD, is dean of the
Sorrell College of Business and Eminent
Scholar in Accounting and Finance at Troy
State University in Troy, Alabama. He is a
member of the AICPA accounting and review
services committee. His e-mail address is
tratclif@troyst.edu .
|
 ne of your small business tax
clients asks you to prepare and report on a set of
financial statements. Because you’re familiar with
the company, you know it has entered into an
interest rate swap to lock in a low rate. The
company also has a significant amount of goodwill
and other intangible assets that may be subject to
impairment as well as considerable fixed assets
still subject to depreciation. It wants financial
statements the company’s owners and executives can
easily understand. You wonder whether there is a
way to comply with the client’s request that is
both cost-effective and less complicated than
GAAP-based financial statements. Before you turn
down the engagement, you might want to consider
preparing and reporting on the financial
statements using an “other comprehensive basis of
accounting” (OCBOA). In situations where
GAAP-basis statements aren’t necessary because of
loan covenants, regulatory requirements or similar
circumstances, an OCBOA may just be the answer.
In this article, CPAs will find
guidance on preparing and reporting on OCBOA
statements, their advantages and some caveats
related to their use. Practitioners also will find
advice that should be useful in preparing and
reporting on modified-cash-basis and tax-basis
financial statements—the most widely used forms of
OCBOA.
WHAT IS AN OCBOA?
Under SAS no. 62,
Special Reports, an OCBOA is any one of
 A statutory basis of accounting (for
example, a basis of accounting insurance companies
use under the rules of a state insurance
commission).
Income-tax-basis financial
statements.
Cash-basis and modified-cash-basis
financial statements.
Financial statements prepared using
definitive criteria having substantial support in
accounting literature that the preparer applies to
all material items appearing in the statements
(such as the price level basis of accounting).
Because tax-basis and cash-basis—including
modified-cash-basis—financial statements are the
most widely used OCBOA statements, the guidance in
this article will focus on them. Exhibit 1
, below, lists some reminders CPAs should find
useful in preparing and reporting on any type of
OCBOA.
| Exhibit 1
: Practical
Reminders on OCBOAs |
| CPAs may audit, review and
compile OCBOA financial statements.
OCBOA financial statements
are simpler and more cost-effective to
prepare, and easier for clients to
understand when compared with GAAP-basis
ones.
Disclosures in OCBOA
financial statements should parallel
those in GAAP-basis statements or
communicate the same information.
The same disclosure
requirements apply in compiled and
reviewed OCBOAs that apply in audited
OCBOAs.
Modifications to the “pure”
cash basis of accounting are acceptable
if they are equivalent to the accrual
basis and the modifications are logical.
CPAs should not go too far
in modifying cash-basis statements so
the essential result is GAAP-basis
statements with GAAP departures.
Tax-basis OCBOAs may
include nontaxable revenue and
nondeductible expenses.
CPAs must modify titles to
OCBOA financial statements to show the
basis of accounting. | GAAP-basis captions may be
used within OCBOA financial statements.
There is no requirement for
a statement of cash flows in OCBOA
financial statements.
A policy note to the
financial statements should describe the
OCBOA.
CPAs face no requirement to
quantify the differences between GAAP
and an OCBOA in describing the basis of
accounting.
Audit, review and
compilation reports should indicate the
financial statements were prepared using
an OCBOA.
Audit reports on OCBOA
financial statements must be modified
for OCBOA departures, inconsistencies
and going-concern issues. Review and
compilation reports should be modified
for OCBOA departures, but there is no
requirement to modify these reports for
inconsistencies and going-concern
issues.
Changing the basis of
accounting in the financial statements
from GAAP to an OCBOA (or vice versa)
necessitates the restatement of
financial statements presented for
comparative purposes.
|
ADVANTAGES OF OCBOA STATEMENTS
When clients ask
about why they should let their CPA prepare
financial statements using an OCBOA, practitioners
should point out that one of the major benefits is
that some clients can understand OCBOA statements
better than GAAP-basis statements. For example, it
isn’t uncommon for the owner/manager of a private
company to fully understand the measurement issues
represented in tax returns while having little
grasp of the measurement and disclosure
complexities in GAAP-basis financial statements.
| Another major advantage: When compared
with GAAP-basis statements, OCBOA
financial statements generally cost less
for CPAs to prepare. In cash- and
modified-cash-basis statements, many of
the measurement principles associated with
GAAP simply don’t exist; in tax-basis
financial statements, the CPA already has
addressed the measurement issues in tax
returns he or she prepared for the client.
Thus practitioners could save clients up
to 20% to 30% and even more in certain
cases because of reduced time and cost in
preparing and reporting on OCBOA financial
statements. A final advantage is that many
external financial statement users such as
banks and insurance companies are now
willing to accept OCBOA statements. CPAs
can use all of these reasons to persuade
clients that OCBOA statements are a good
idea for their business. Since
disclosure requirements for OCBOA
statements generally parallel those for
GAAP-basis statements, CPAs will find
only limited benefits, including minimal
cost savings, when it comes to this
aspect of preparing OCBOA statements.
Interpretation no. 14 of SAS no. 62,
Evaluating the Adequacy of
Disclosure in Financial Statements
Prepared on the Cash, Modified Cash,
or Income Tax Basis of Accounting,
gives practitioners expanded
guidance on disclosure requirements. It
says disclosures in these types of
statements should parallel those for
GAAP-basis statements or should
communicate the substance of the GAAP
disclosures. | |
| Exhibit
2 :
Sample Audit Report/OCBOAs
|
|
MUNTER &
RATCLIFFE
CERTIFIED
PUBLIC ACCOUNTANTS
123 Bibb
Graves Street
Miami, Florida
33124
(305)
670-3137
Independent
Auditors’ Report
Sue
Beasley, President
Ann Wholesale
Inc.
Petrey,
Alabama We
have audited the
accompanying
statements of
assets, liabilities
and stockholders’
equity—income tax
basis of Ann
Wholesale Inc. as of
December 31, 2002
and 2001, the
related statements
of revenues and
expenses—income tax
basis for the years
then ended. These
financial statements
are the
responsibility of
the company’s
management. Our
responsibility is to
express an opinion
on these financial
statements based on
our audits.
We conducted our
audits in accordance
with auditing
standards generally
accepted in the
United States of
America. Those
standards require
that we plan and
perform the audits
to obtain reasonable
assurance about
whether the
financial statements
are free of material
misstatement. An
audit includes
examining, on a test
basis, evidence
supporting the
amounts and
disclosures in the
financial
statements. An audit
also includes
assessing the
accounting
principles used and
significant
estimates made by
management, as well
as evaluating the
overall financial
statement
presentation. We
believe our audits
provide a reasonable
basis for our
opinion. As
described in Note 1,
these financial
statements were
prepared on the
basis of accounting
the company uses for
federal income tax
purposes, which is a
comprehensive basis
of accounting other
than generally
accepted accounting
principles.
In our opinion,
the financial
statements referred
to above present
fairly, in all
material respects,
the assets,
liabilities and
stockholders’ equity
of Ann Wholesale
Inc. as of December
31, 2002 and 2001,
and its revenues and
expenses for the
years then ended, on
the basis of
accounting described
in Note 1.
Munter &
Ratcliffe, CPAs
March 15,
2003
| | |
CPAs will find disclosure to be simpler when
OCBOA statements do not include some of the items,
events and transactions typically part of
GAAP-basis statements. For example, since
tax-basis statements don’t show deferred taxes,
CPAs don’t have to prepare the deferred tax
disclosures GAAP-basis statements require.
Practitioners should remember there is no
disclosure “advantage” when they have compiled or
reviewed OCBOA financial statements vs. auditing
them. The advantage results from using another
basis of accounting to prepare the financial
statements and not from the level of service
(audit, review or compilation) the CPA provides.
Of course, the statements on standards for
accounting and review services (SSARSs) allow CPAs
to compile financial statements when management
elects to omit substantially all of the
disclosures. This applies both to GAAP-basis and
OCBOA statements.
CASH- AND MODIFIED-CASH-BASIS STATEMENTS
Under the cash basis
of accounting, CPAs record transactions according
to an entity’s cash receipts and disbursements.
The entity recognizes certain revenue when it
receives cash rather than when it earns the
income, and recognizes certain expenses when it
pays them rather than when it incurs the
obligation. CPAs rarely use the “pure” cash basis
of accounting in practice; they use it almost
exclusively for clients such as estates and trusts
and civic ventures. Typically, both for-profit and
not-for-profit entities use the modified cash
basis in cash-basis OCBOAs. | The modified cash
basis of accounting is a hybrid approach
that combines elements of the cash- and
accrual-basis methods. Modifications CPAs
make to the cash basis should have
substantial support in the accounting
literature. SAS no. 62 cites as examples
two modifications that meet these
criteria: depreciation on fixed assets and
accruing income taxes. However, CPAs can
use other modifications as long as they
are logical and have substantial support
in the accounting literature. For this to
be true, accountants should report on
interrelated accounts on the same basis.
For example, when a CPA records a fixed
asset, he or she should record
depreciation on those assets. While it
is common for CPAs to “modify”
cash-basis statements to include fixed
assets and the related depreciation, and
to record liabilities for short-term and
long-term borrowings and the related
interest cost, practitioners should not
go so far in modifying cash-basis
statements so in the end they have
prepared GAAP-basis statements. For
example, a company shouldn’t accrue
trade receivables and payables in
modified-cash-basis statements; it also
shouldn’t record deferred taxes and
capital leases. To do so means the CPA
has prepared GAAP-basis statements,
losing the advantages of the OCBOA.
| | | Exhibit
3 :
Sample Review Report/OCBOAs
|
|
MUNTER &
RATCLIFFE
CERTIFIED
PUBLIC ACCOUNTANTS
123 Bibb
Graves Street
Miami, Florida
33124
(305)
670-3137
Independent
Auditors’ Report
Sue
Beasley, President
Ann Wholesale
Inc.
Petrey,
Alabama We
have reviewed the
accompanying
statements of
assets, liabilities
and stockholders’
equity—income tax
basis of Ann
Wholesale Inc. as of
December 31, 2002
and 2001, and the
related statements
of revenues and
expenses—income tax
basis for the years
then ended, in
accordance with
Statements on
Standards for
Accounting and
Review Services
issued by the
American Institute
of CPAs. All
information included
in these financial
statements is the
representation of
the owners of Ann
Wholesale Inc.
A review consists
principally of
inquiries of company
personnel and
analytical
procedures applied
to financial data.
It is substantially
less in scope than
an audit of
financial statements
in accordance with
generally accepted
auditing standards,
the objective of
which is the
expression of an
opinion regarding
the financial
statements taken as
a whole.
Accordingly, we do
not express such an
opinion.
Based on our
reviews, we are not
aware of any
material
modifications that
should be made to
the accompanying
financial statements
in order for them to
be in conformity
with the income tax
basis of accounting,
as described in Note
1.
Munter &
Ratcliffe, CPAs
March 15,
2003
| | |
TAX-BASIS STATEMENTS
The income tax basis
of accounting follows the provisions of the
federal income tax law. It covers a range of
reporting alternatives, from cash to full accrual,
depending on the nature of the taxpayer and, in
some circumstances, the taxpayer’s elections.
Here are some of the practical issues CPAs will
encounter when preparing and reporting on
tax-basis statements:
The statements may include both
nontaxable revenue and nondeductible expenses.
The statements should treat changes
in accounting principle in the same manner as on
the tax return.
S corporations should combine the
accumulated-adjustments account, previously taxed
income from pre-1983 years and accumulated
earnings and profit into one retained earnings
account for financial statement presentation
purposes.
DISCLOSURE GUIDELINES
Perhaps the most
difficult issue practitioners need to address in
preparing and reporting on OCBOA financial
statements—whether cash basis or tax basis—relates
to the adequacy of disclosure within those
statements. As previously mentioned SAS no. 62 and
Interpretation no. 14 give CPAs valuable guidance
on these concerns. Following are some of the
unique disclosure issues associated with OCBOA
financial statements:
Statement titles should clearly
identify the basis of accounting used.
The inclusion of a statement of cash
flows is not required.
Disclosures should include policy
notes paralleling those in GAAP-basis statements
and a basis of accounting policy note that clearly
identifies the primary differences between GAAP
and the OCBOA.
The notes to the statements should
include disclosures related to contingent
liabilities, going-concern considerations and
risks and uncertainties.
OTHER REPORTING ISSUES
SAS no. 62
contains audit guidance for when a client
engages the practitioner to audit OCBOA
financial statements. Exhibit 2
illustrates the modifications to the
audit report that are necessary for CPAs
to use the standard audit report on OCBOA
financial statements. Interpretation no.
12 of SSARS no. 1, Reporting on a
Comprehensive Basis of Accounting Other
Than Generally Accepted Accounting
Principles, provides important
guidance for CPAs engaged to review or
compile OCBOA financial statements.
Exhibit 3 and exhibit 4
illustrate the modifications to the
review and compilation reports that are
necessary for CPAs to use the standard
reports with OCBOA financial statements.
Paralleling the guidelines for
reporting on GAAP-basis statements, the
rules for OCBOA statements may result in
CPAs’ needing to modify standard audit,
review and compilation reports on these
statements. The following is a list of
some of the more common areas where
accountants may need to modify reports.
OCBOA departures could
result in the need for an auditor to
qualify the opinion expressed in audit
reports and CPAs might need to spell out
these departures in review and
compilation reports.
Changes in accounting
principles within an OCBOA could result
in CPA’s needing to add an inconsistency
paragraph in audit reports; there is no
parallel requirement for accountants to
modify review and compilation reports
for inconsistencies in the application
of accounting principles, although they
may do so. | |
| Exhibit
4 :
Sample Compilation
Report/OCBOAs
|
|
MUNTER &
RATCLIFFE
CERTIFIED
PUBLIC ACCOUNTANTS
123 Bibb
Graves Street
Miami, Florida
33124
(305)
670-3137
Independent
Auditors’ Report
Sue
Beasley, President
Ann Wholesale
Inc.
Petrey,
Alabama We
have compiled the
accompanying
statements of
assets, liabilities
and stockholders’
equity—income tax
basis of Ann
Wholesale Inc. as of
December 31, 2002
and 2001, and the
related statements
of revenues and
expenses—income tax
basis for the years
then ended, in
accordance with
Statements on
Standards for
Accounting and
Review Services
issued by the
American Institute
of CPAs. These
financial statements
have been prepared
on the income tax
basis of accounting,
which is a
comprehensive basis
of accounting other
than generally
accepted accounting
principles.
A compilation is
limited to
presenting in the
form of financial
statements
information that is
the representation
of management (the
owners). We have not
audited or reviewed
the accompanying
financial statements
and, accordingly, do
not express an
opinion or any other
form of assurance on
them.
Management has
elected to omit
substantially all of
the disclosures
ordinarily included
in the financial
statements prepared
on the income tax
basis of accounting.
If the omitted
disclosures were
included in the
financial
statements, they
might influence the
user’s conclusions
about the company’s
assets, liabilities,
equity, revenues and
expenses.
Accordingly, these
financial statements
are not designed for
those who are not
informed about such
matters.
Munter &
Ratcliffe, CPAs
March 15,
2003 |
| Note:
Obviously, if the
compiled financial
statements are
full-disclosure
financial statements,
CPAs would delete the
third paragraph in
this compilation
report. Further, since
full-disclosure
financial statements
would include a policy
note describing the
basis of accounting
utilized in the
financial statements,
the last sentence in
the first paragraph of
this report would be
unnecessary.
Essentially, in
full-disclosure
financial statements,
the “standard report”
associated with
GAAP-basis statements
can be used when
reporting on OCBOA
financial statements
(although the
financial statement
titles will be
modified).
| | |
When a CPA concludes the entity is
not a going concern in an audit engagement, he or
she should modify the audit report on OCBOA
statements in the same way the practitioner would
modify the report when auditing GAAP-basis
statements; an accountant faces no parallel
requirement to modify review and compilation
reports for going-concern issues, although he or
she may do so.
A change in the basis of accounting
from GAAP to OCBOA (or vice versa) results in the
requirement for clients to restate financial
statements presented for comparative purposes; in
these circumstances, CPAs might decide they should
modify audit, review and compilation reports to
emphasize this change.
A POPULAR ALTERNATIVE
Since the ASB issued
SAS no. 62 in April 1989, CPAs have increased
their use of OCBOA financial statements. With the
growing complexity of accounting guidance
associated with GAAP-basis statements,
practitioners may be looking for a logical
alternative to preparing and reporting on
financial statements that result in more
understandable and cost-beneficial statements for
clients. Such an alternative may be to prepare and
report on OCBOA financial statements. With the
recent changes in the regulatory landscape
including enhancements to GAAP reporting
requirements, there is little question OCBOA
statements will continue to gain in popularity
with both preparers and users of financial statements. |
Leases standard: Tackling implementation — and beyond