The only accounting method accepted by GAAP, or generally accepted accounting principles, is the accrual basis accounting method. This method applies the matching principle by recording revenue when it is earned and expenses as they occur. Accrual basis, however, isn’t the only accounting method used for presenting financial statements. Cash basis, modified cash basis and income tax basis are other accounting methods, and the financial statements derived form these are called other comprehensive basis of accounting, or OCBOA, statements.

What Is GAAP?

The GAAP is put together by the American Institute of Certified Public Accountants. Any accountant or CPA who presents a financial statement must follow these standards. If the financial statement strays from GAAP in any way – for example by using cash basis accounting instead of accrual – the CPA cannot say the the financial statement conforms with GAAP.

Accrual Basis Accounting

Accrual basis is the method of accounting for revenue and expenses when they are earned or incurred, regardless of when cash actually is deposited in the company’s account.

Say a company makes a sale in November but the customer doesn’t pay it until December. In the financial statement, it would show that the revenue was made in November, even though it didn’t actually arrive as a payment until a month later. The same goes for expenses. A company buys supplies in June but doesn’t get the bill until July, and the cash doesn’t reach the vendor until August. As with revenue, the financial statement will show that the expense was incurred in June even though the money didn’t leave the company until August.

Benefits of Accrual Basis Accounting

One of the benefits of using the GAAP-approved accrual method is that a company has a better idea of what it costs to run the business each month and knows better how much money it makes. By recording revenues as they happen, the company can estimate how much money it will have each month and can determine how much it can spend and how much will be profit. By recording how much it spends each month, the company can anticipate how much revenue it would need each month to cover all expenses.

GAAP Versus Other Basis Methods

Cash basis accounting is not acceptable under GAAP, but financial statements can be done using cash basis accounting; in this case, the CPA who prepared the statement will have to present it as a non-GAAP financial statement or an other comprehensive basis of accounting financial statement. Cash basis accounting records transactions when cash comes in or leaves the company’s account. With this method, a company can show smaller revenue at income tax filing and therefore have a smaller tax burden if it is paid the following tax year for revenue earned in the current tax year.