Preparing Tax Basis Financial Statements

• Chapter 0 - Overview
  • Course Objectives
  • Introduction
  • Organization
  • Conclusion
• Chapter 1 - OCBOA Financial Statements – Overview and Authoritative Guidance
  • Learning Objectives
  • Introduction
  • Guidance for OCBOA Financial Statements
    • AU Section 623
    • AU Section 623 Interpretation
    • AR Section 100
    • Technical Practice Aids
  • Questions
• Chapter 2 - Financial Statement Considerations
  • Learning Objectives
  • Introduction
  • Primary Financial Statements
    • Economic Resources and Obligations
    • Changes in Economic Resources and Obligations
    • Cash Flows
    • Other Statements
  • Presentation
  • Financial Statement Titles
  • Financial Statement Captions
    • Classified Versus Unclassified Presentation
  • Other Presentation Issues
    • Consolidation Accounting
    • Change from GAAP to OCBOA
  • References in the Financial Statements
    • References to the Notes
    • References to Selected Information
    • References to the Accountant’s Report
    • Management-Use-Only Financial Statements
    • Placing the Reference
  • Financial Statement Disclosures
    • Format of Disclosures
    • Title of Notes
    • Summary of Significant Accounting Policies
    • Financial Statement Items
    • Presentation Requirements
    • Other Information
    • Omission of Disclosures
  • Supplementary Information
    • Reporting on Supplementary Information
  • Form and Style of Presentation
    • Title Page
    • Accountant’s Report
  • Questions
• Chapter 3 - Income Tax Basis – Accounting Issues
  • Learning Objectives
  • Introduction
  • IRS Accounting Methods
    • Inventories
    • Exceptions
    • Methods Permitted
  • Accounting Issues to Consider
    • Nontaxed Entities
    • Nontaxable Revenues and Nondeductible Expenses
    • Tax Changes
    • Changes in Equity and Capital Accounts
  • Accrual Method
    • Safe Harbor Rule
    • Recurring Item Exception
    • Revenue and Expense Measurement and Presentation Issues
    • Balance Sheet Measurement and Presentation Issues
  • Cash Method
    • Constructive Receipt
    • Expenses
    • Measurement and Presentation Issues
  • Questions
• Chapter 4 - Income Tax Basis – Disclosure Issues
  • Learning Objectives
  • Introduction
  • Basis of Accounting
    • Accrual Method
    • Cash Method
  • Summary of Significant Accounting Policies
    • Income Taxes
    • Consolidation
    • Inventory
    • Receivables
    • Depreciation
    • Start-Up Costs
    • Related Party Transactions
    • Commitments and Contingencies
    • Uncertainties
    • Subsequent Events
    • Asset Impairment
    • Changes in Accounting Principles or Estimates
    • Investments
    • Property and Equipment
    • Terms of Debt Agreements
    • Restrictions on Assets and Equity
    • Employee Benefit Plans
    • Income Taxes
  • Nontaxable Entities
    • S Corporation
    • Partnership
    • Limited Liability Company
    • Sole Proprietorship
  • Questions
• Chapter 5 - Compiling Income Tax Basis Financial Statements
  • Learning Objectives
  • Introduction
  • Reporting Standards
    • Financial Statement Legends
    • Report Address
    • Report Date
    • Report Signature
  • Modifications to the Standard Report
    • Lack of Independence
    • Departures from the OCBOA
    • Restricted Use Financial Statements
    • Omission of Substantially All Disclosures
    • Inclusion of More than a Few Disclosures
  • Questions
• Chapter 6 - Latest Developments
• Appendix A - Illustrative Income Tax Basis Presentation

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Chapter 1 - OCBOA Financial Statements – Overview and Authoritative Guidance

Learning Objectives

• Understand the general nature of OCBOA financial statements.

• Be aware of the key issues in preparing OCBOA financial statements.

• Recognize basic guidance found in AU Section 623.

• Be aware of other sources of guidance for OCBOA financial statements.

Introduction

The income tax basis of accounting is considered an other comprehensive basis of accounting. The term other comprehensive basis of accounting (OCBOA) refers to bases of accounting other than generally accepted accounting principles (GAAP). Historically, the primary guidance for OCBOA financial statements came from AU Section 623 (previously indexed as SAS No. 62), Special Reports. In 2008, AR Section 100 (previously indexed as SSARS No. 1), Compilation and Review of Financial Statements, was amended to included guidance related to OCBOA financial statements. Unlike GAAP, there is no standard-setting organization for OCBOA. Instead, preparers and accountants have interpreted the audit guidance in AU Section 623 for purposes of preparing OCBOA financial statements. AU Section 623.03 states that “an independent auditor’s judgment concerning the overall presentation of financial statements should be applied within an identifiable framework.” Ordinarily, that framework is provided by GAAP; but AU Section 623 and AR Section 100 allow a comprehensive basis of accounting other than GAAP to be used. AU Section 623.04 and AR Section 100.04 recognize the following OCBOAs:

• The basis of accounting the reporting entity uses to comply with the requirements or financial reporting provisions of a governmental regulatory agency whose jurisdiction the entity is subject.

• 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 cash receipts and disbursements basis of accounting, and modifications of the cash basis having substantial support, such as recording depreciation on fixed assets or accruing income taxes.

• A definite set of criteria having substantial support that is applied to all material items appearing in financial statements, such as the price-level basis of accounting.

Income Tax Basis

The income tax basis of accounting typically is based on federal income tax laws. Income tax laws generally do not address financial statement presentation or disclosure considerations, however.

Typically, entities that use the tax basis of accounting are either

• Profit oriented enterprises (such as small, closely held companies for which conversion to GAAP would be costly).

• Partnerships whose partnership agreements require the use of the tax basis of accounting.

• Not-for-profit organizations seeking relief from the requirements of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 958, Not-for-Profit Entities, (SFAS No. 116 and SFAS No. 117).

Guidance for OCBOA Financial Statements

Historically, the primary guidance for OCBOA financial statements was found in AU Section 623. However, in 2008, AR Section 100 was amended to provide guidance related to compiling and reviewing OCBOA financial statements. AU Section 623, and related interpretations, address the general definition of the term other comprehensive basis of accounting, financial statement titles, and financial statement disclosures. In addition, AU Section 623 provides guidance for the auditor’s report. AR Section 100 (previously indexed as SSARS No. 1), Compilation and Review of Financial Statements, and related interpretations, contain additional guidance concerning compilation and review of OCBOA financial statements. Finally, AICPA Technical Practice Aids provide guidance for several OCBOA preparation and reporting circumstances.

Observation: Although AU Section 623 is an audit standard, guidance (particularly that related to financial statement disclosures) is relevant for compiling or reviewing OCBOA financial statements.

AU Section 623

AU Section 623.03 states that “an independent auditor’s judgment concerning the overall presentation of financial statements should be applied within an identifiable framework.” Ordinarily, that framework is provided by GAAP and the auditor’s judgment in forming an opinion is applied accordingly; but AU Section 623 allows a comprehensive basis of accounting other than GAAP to be used.

Financial Statement Titles

AU Section 623.07 also addresses the issue of financial statement titles. Terms such as balance sheet, statement of financial position, statement of income, statement of operations, and statement of cash flows, or similar unmodified titles are generally understood to be applicable only to GAAP financial statements. Accordingly, you should modify the titles of OCBOA financial statements. For example, cash basis financial statements might be titled statement of assets and liabilities arising from cash transactions, or a statement of revenue collected and expenses paid, and a financial statement prepared on a statutory or regulatory basis might be titled statement of income – statutory basis.

Disclosures

When reporting on OCBOA financial statements, the financial statements, including the accompanying notes, should include all informative disclosures that are appropriate for the basis of accounting used.

Notes accompanying OCBOA financial statements should include a summary of significant accounting policies that discusses the basis of presentation and describes how that basis differs from GAAP. However, the effects of the differences between GAAP and OCBOA used need not be quantified. In addition, AU Section 623.10 states that when the financial statements contain items that are the same as, or similar to, those in GAAP financial statements, similar disclosure should be included. For example, income tax basis financial statements and modified cash basis financial statements usually reflect depreciation, long-term debt, and owners’ equity. Thus, the disclosures for depreciation, long-term debt, and owners’ equity in such financial statements should be comparable to those in GAAP financial statements. You should also consider disclosures related to matters not specifically identified on the face of the financial statements, such as

• Related party transactions.

• Restrictions on assets and owners’ equity.

• Subsequent events.

• Uncertainties.

AU Section 623 Interpretation

In 1998, the Auditing Standards Board issued Interpretation No. 14 of SAS No. 62, “Evaluating the Adequacy of Disclosure and Presentation in Financial Statements Prepared in Conformity with an Other Comprehensive Basis of Accounting” (now indexed at AU Section 9623).

AU Section 9623 states that the discussion of the basis of accounting, required by AU Section 623.10, may be brief and only needs to describe the primary differences from GAAP. For example: “The accompanying financial statements present financial results on the accrual method of accounting used for federal income tax reporting.” To further illustrate, if several items are accounted for differently than they would be under GAAP, but only the differences in depreciation calculation are significant, a brief description of the depreciation differences is all that would be necessary. The remaining differences need not be described. Also, quantifying the differences is not required.

AU Section 9623 also states that if OCBOA financial statements contain elements, accounts, or items for which GAAP would required disclosure, the OCBOA financial statements should either

• Provide the relevant disclosure that would be required for those items under GAAP, or

• Provide information that communicates the substance of that disclosure.

In order to provide information that communicates the substance of a GAAP disclosure, you may substitute qualitative information for some of the quantitative information required by GAAP. For example, disclosing the repayment terms of significant long-term borrowings may sufficiently communicate information about future principal reduction without providing the summary of principal reduction during each of the next five years that would be required for a GAAP presentation. Similarly, disclosing estimated percentages of revenues, rather than amounts that GAAP presentations would require, may sufficiently convey the significance of sales or leasing to related parties.

GAAP disclosure requirements that are not relevant to the measurement of the element, account, or item are not required. The following examples illustrate this situation:

• FASB ASC 320, Investments – Debt and Equity Securities (SFAS No. 115), requires disclosure of fair value information for debt and equity securities reported in GAAP presentations. This disclosure would not be relevant when the basis of presentation does not adjust the cost of such securities to their fair value.

• FASB ASC 715, Compensation Retirement Benefits (SFAS No. 87), requires disclosure of information about contributions to defined benefit plans based on actuarial calculations in GAAP presentations. This disclosure would not be relevant in income tax or cash basis financial statements.

AU Section 9623 states “If GAAP sets forth requirements that apply to the presentation of financial statements, then OCBOA financial statements should either comply with those requirements or provide information that communicates the substance of those requirements.” The substance of GAAP presentation requirements may be communicated using qualitative information and without modifying the financial statement format. AU Section 9623.93 provides the following examples:

1. Information about the effects of accounting changes, discontinued operations, and extraordinary items could be disclosed in a note to the financial statements without following the GAAP presentation requirements in the statement of income, without using those terms, or without disclosing the net-of-tax effects.

2. Instead of showing expenses by their functional classifications, the income tax basis statement of activities of a not-for-profit organization could present expenses according to their natural classifications, and a note to the statement could use estimated percentages to communicate information about expenses occurred by the major program and supporting services. A voluntary health and welfare organization could take such an approach instead of presenting the matrix of natural and functional expense classifications that would be required for a GAAP presentation. Or, if information has been gathered for the IRS Form 990 matrix required for such organizations, it could be presented either in the form of a separate statement or in a note to the financial statements.

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