You don’t have to be Tom Petters or Al Capone to have two sets of books. In fact, I believe that most if not all businesses can benefit from having two sets of books (financial statements), legally. One set to manage their business and provide information to 3rd parties like banks and owners or stockholders, and a second set to file the company’s tax return.
The first set is usually on an accrual basis using the accounting rules or generally accepted accounting principles (GAAP) with the intentions of really seeing how the business is doing. These accrual GAAP statements are used by third parties to measure cash flow, net income, debt service coverage or other financial information using the same standardized rules as other similar businesses. These GAAP statements also are great tools for management to see monthly if they’re on track to hit their business and financial goals and provide clues on what might have to change if they’re not hitting the mark. The statements used to file the tax return generally have one purpose…. minimize net income and thus, taxable income at year-end so the owners pay the least amount of income taxes possible.
The problem occurs in the CPA world where the GAAP rules continue to get more and more complex in that many in the industry now simply recommend using just one set of books; a tax basis set of books for most small businesses. Ultimately they argue that this helps the company with their tax return as well as also producing a financial statement for third parties (usually compiled statements as opposed to reviewed or audited). These financial statements are not GAAP statements but are tax basis statements which are considered an other comprehensive basis of accounting (OCBOA).
In many cases I think this is a disservice to the business since the objectives of financial reporting for a business and tax reporting for a business are generally polar opposites. As discussed above, with one we want to show profits, equity and good accurate information and with the other we love to show losses. How can there be such a big difference you ask? Everything from depreciation, tax credits, cash basis of accounting, industry specific accounting and innumerable other differences between accounting and tax rules are the primary culprits.
So who cares about this anyway? The folks with the money, that’s who! Banks, investors, leasing and other financing sources generally all want GAAP statements. Also, generally GAAP will show more accurately the economics of the business and typically in a better light (more equity more collateral, etc.). The other significant issue is I’ve seen small and big businesses look too closely at tax basis information and lose sight of the true realities of the business (GAAP statements) and ultimately falter because they weren’t using the best information to manage their business day to day. Talk to your accountant and they can help walk you through this and help you in your business. The bottom line is if you’re using tax numbers for the bank, third parties or to manage your business, why not give two sets of books a try? You can legally do this without fear of the results Mr. Capone experienced!