27 Sep What is a Basis of Accounting?
In our piece titled Regulatory Changes to Corporate Financial Statements at the end of 2021, we talked about some changes to the way we will be required to prepare corporate financial statements. Now, we are going to discuss one of those changes, the concept of a basis of accounting, a bit further.
Starting at the end of 2021, we will be required to include a note on the financial statements that we compile for our clients disclosing the basis of accounting. The purpose of the note is to assist anyone reading the financial statements in their understanding of how they have been prepared. Examples of simple bases of accounting that may be used in the preparation of financial statements are:
- A cash basis of accounting where all transactions are recorded on the date cash is paid or received;
- A cash basis of accounting with selected accruals which would include items like receivables for products and services provided to customers where collection of the cash is still outstanding, and payables for products and services obtained from vendors where the cash payment still needs to me made; or
- A basis of accounting prescribed by a contract or other form of agreement established by a creditor such as a bank or a regulator such as a government entity.
There is no single basis of accounting that is appropriate for all entities or all situations. The appropriate basis of accounting depends on items such as the applicable industry and the relevant tax laws and rules. As your external accounting firm, Clearline CPA will help you select the appropriate basis of accounting. However, regulations in Canada require that the basis of accounting be the responsibility of its shareholders and directors. While we will assist you with the preparation of the financial statements and the basis of accounting, the final versions must be approved by you.
The following is an example of a basis of accounting note for a commercial real estate leasing company:
Basis of Accounting
The basis of accounting applied in the preparation of the balance sheet of ACME Leasing as at December 31, 20X1, and the income statement for the year then ended, is the historical cost basis and reflects cash transactions with the addition of:
- Rent receivable based on lease terms, less an allowance for doubtful accounts;
- Revenue-producing property recorded at historical cost and amortized in accordance with amounts allowable for income tax purposes;
- Accounts payable and accrued liabilities;
- Current income taxes payable as at the reporting date; and
- Rental revenue recorded in accordance with the lease terms.
So, to summarize the above, a description of the basis of accounting used to prepare the financial statements will be included in a note disclosure. Clearline will have a discussion with you regarding the expected wording of the basis of accounting in the early stages of the compilation engagement process. At the end of the process, when we discuss the financial statements and corporate taxes with you, we will ask you to acknowledge that you have taken responsibility for the final version of the compiled financial information, which includes the description of the basis of accounting.