Question 1: May an entity that uses the cash basis of accounting to prepare its federal income tax return issue financial statements on the income tax basis of accounting using the accrual basis?
Response: SSARS No. 19 defines OCBOA to include income tax basis financial statements. However, the income tax basis is defined as “a basis of accounting that the reporting entity uses or expects to use to file its income tax return for the period covered by the financial statements.
What this means is that the entity must use the basis used or expected to be used to prepare its tax return. Thus, if the tax return is prepared on the cash basis, the income tax basis financial statements must also be on a cash basis. Further, if the entity wishes to prepare income tax basis financial statements on an accrual basis, it must file its income tax return on an accrual basis.
This situation is problematic for many companies who file their income tax return on a cash basis, yet wish to prepare income tax basis financial statements on an accrual basis, as it is more meaningful to do so. Such a scenario is not authorized by SSARS No.
19.
The solution—the income tax basis of accounting departure!
One way to issue income tax basis financial statements on an accrual basis, while continuing to file cash basis income tax returns, is to issue a report with an income tax basis of accounting departure, similar to a GAAP departure. The difference is that there is a departure from the rules for the income tax basis of accounting (found in SSARS No. 19 rather than GAAP.) SSARS No. 19 requires the basis to be the same as the one used for filing the income tax return. By preparing accrual basis financial statements, the entity is violating SSARS No. 19.
Following are sample reports:
Compilation Report- Income Tax Basis of Accounting with Report Exception
Accountant’s Compilation Report Board of Directors
XYZ Company 55 North Street,
Boston, Massachusetts 02113
We have compiled the accompanying statement of assets, liabilities and stockholders’
equity- income tax basis of XYZ Company as of December 31, 20XX, and the related statement of revenue, expenses and retained earnings-income tax basis for the year then ended. We have not audited or reviewed the accompanying financial statements and, accordingly, do not express an opinion or provide any assurance about whether the financial statements are in accordance with the income tax basis of accounting.
Management is responsible for the preparation and fair presentation of the financial statements in accordance with the income tax basis of accounting and for designing, implementing, and maintaining internal control relevant to the preparation and fair presentation of the financial statements.
Our responsibility is to conduct the compilation in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants. The objective of a compilation is to assist management in presenting financial information in the form of financial statements without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements. During our compilation, I (we) did become aware of a departure from the income tax basis of accounting that is described in the following paragraph.
The income tax basis of accounting requires that financial statements prepared on the income tax basis of accounting use the same basis used or expected to be used to file the Company’s income tax return. Management has informed us that the company has prepared the accompanying financial statements on the accrual basis of accounting while it files its federal income tax return on the cash basis of accounting. If the cash basis had been followed, net income and stockholders’
equity would have decreased by $100,000.
Management has elected to omit substantially all of the disclosures ordinarily included in financial statements prepared in accordance with the income tax basis of accounting.
If the omitted disclosures were included in the financial statements, they might
influ-100
TOP ACCOUNTING ISSUES FOR 2015 CPE COURSEence the user’s conclusions about the company’s assets, liabilities, equity, revenue, and expenses. Accordingly, the financial statements are not designed for those who are not informed about such matters.
James J. Fox & Company, CPA
[Date (date of completion of compilation engagement)]
Review Report-Income Tax Basis of Accounting with Report Exception Independent Accountant’s Review Report
Board of Directors XYZ Company 55 North Street
Boston, Massachusetts 02113
We have reviewed the accompanying statement of assets, liabilities, and stockholders’
equity—income tax basis of XYZ Company as of December 31, 20XX, and the related statement of revenue, expenses and retained earnings, and cash flows—income tax basis for the year then ended. A review includes primarily applying analytical proce-dures to management’s financial data and making inquiries of company management. A review is substantially less in scope than an audit, the objective of which is the expression of an opinion regarding the financial statements as a whole. Accordingly, we do not express such an opinion.
Management is responsible for the preparation and fair presentation of the financial statements in accordance with the income tax basis for accounting and for designing, implementing, and maintaining internal control relevant to the preparation and fair presentation of the financial statements.
Our responsibility is to conduct the review in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants. Those standards require us to perform procedures to obtain limited assurance that there are no material modifications that should be made to the financial statements. We believe that the results of my (our) procedures provides a reasonable basis for our report.
Based on our review, with the exception of the matter described in the following paragraph, 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.
As described in Note 2, the income tax basis of accounting requires that finan-cial statements prepared on the income tax basis of accounting use the same basis used or expected to be used to file the Company’s income tax return.
Management has informed us that the company has prepared the accompanying financial statements on the accrual basis of accounting while it files its federal income tax return on the cash basis of accounting. If the cash basis had been followed, net income and stockholders’ equity would have decreased by
$100,000.
James J. Fox & Company, CPA [Date]
NOTE: Effective in 2012, auditing standards eliminated the term “OCBOA
and replaced it with the term “special purpose framework, as found in AU-C Section 800, Special Considerations—Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks.
In January 2013, the Auditing Standards Board issued SAS No. 127, Omnibus Statement on Auditing Standards—2013. SAS No. 127 added a new category to the definition of a special purpose framework (formerly OCBOA) which is defined as:
Other basis: A basis of accounting that uses a definite set of logical, reasonable criteria that is applied to all material items appearing in financial statements.
This new category appears to capture any framework that has a set of logical, reasona-ble criteria and could include a framework based on income tax basis financial state-ments prepared on a method other than the one used to file the entity’s tax return. For example, an entity prepares its tax return on the cash basis but wishes to issue income tax basis financial statements on the accrual basis.
The definition of income tax basis financial statements found in SSARS No. 19 has not yet been modified to include the SAS No. 127 definition that includes the “other basis category.