What is More Beneficial for Professional Service Organizations: Accrual Basis or Cash Basis Financial Statements?

One of the most important decisions management of a professional service organization needs to make as it relates to their financial statements is the reporting method that will be followed.  Most professional service organizations elect to report their financial statements on the accrual basis of accounting which is in accordance with accounting principles generally accepted in the United States of America (GAAP); however, some professional service organizations report on a cash basis (either a modified cash basis or a pure cash basis). The following are the three largest advantages and disadvantages of reporting financial statements on a cash basis.

                The largest advantage of reporting on the cash basis of accounting is that new accounting standards will not have a significant effect on the organization’s financial statements. The Financial Accounting Standards Board (FASB) issues accounting standards updates (ASUs) on a regular basis that are effective for GAAP basis reporting entities; however, these standards rarely apply to cash basis reporting entities. Time and resources are needed to implement new ASUs; therefore, if an organization is reporting on a cash basis, the additional costs are not incurred and additional resources are not needed. A second advantage of reporting on the cash basis of accounting is that it allows a user of the financial statements to depict a more accurate picture of the cash flow and operations of an organization. The third advantage of a cash basis reporting model is easier tracking of revenue.

                The largest disadvantage of reporting on the cash basis of accounting is the cash basis of accounting is a framework that is not in accordance with GAAP. If a professional service organization s outside debt with financial institutions, debt agreements usually require audited or reviewed financial statements in accordance with GAAP. The professional service organization would need to have the approval of the financial institution to provide cash basis financial statements in lieu of GAAP financial statements. A second disadvantage of reporting on the cash basis is that it can often be difficult to benchmark the organization against competitors or other organizations within the same industry, since most companies report under an accrual method. A third disadvantage is the cost and time that is incurred if the organization is required to switch from the cash basis to the accrual basis of accounting as a result of a transaction.  For example, if an entity enters into a transaction whereby a new investor is brought in, the investor may require GAAP-based financials to be produced. The transition from the cash basis to the accrual basis of accounting to realign revenues and expenses can be costly and time-consuming.

                While there are both advantages and disadvantages for professional service organizations to report on the cash basis of accounting, the size of the entity and the requirements of the users of the financial statements should be reviewed.

                When considering the type of reporting model for your organization, feel free to reach out to one of the Schneider Downs Professional Service Industry team members.