As 2018 has drawn to a close, many contractors are working on their year-end financials. Your company may want to consider having your accountant prepare an accrual basis financial statement in addition to the standard income tax basis financial statement. This accrual basis financial statement can then be used with your bond application. If your accountant is providing you with only an income tax basis financial statement for your bond application remember this, income tax basis financial statements almost always understate your company’s financial strength and performance. Over the next several blog posts, we will look at some of the differences between the two types of financial statements and how they can affect your surety program.
Both of these two types of financial statements are legitimately used for different purposes. Income tax basis financial statements are prepared from the information on your company’s income tax returns. They only reflect figures and formulas used to determine your tax obligations each year. Accrual basis financial statements, by contrast, organize your company’s financial information differently and are designed to more precisely state your company’s financial condition, its performance over time, and its net worth.
One area that illustrates how these two different types of financial statements can affect a company’s bond application is in the treatment of expenses and income. When preparing income tax returns, your account shows the IRS all a company’s expenses for the year including all prepaid expenses. These are then deducted against your company’s taxable income. However, in order to keep your tax obligations low, the account doesn’t include all income earned in connection with the stated expenses. Thus, income tax basis financial statements will show your company to have higher expenses and lower cash balance with no additional earned income to offset these negative.
Accrual financial statements on the other hand allow you to offset expenses in any given year with the income earned in connection with those expenses. This is a better presentation of your company’s work on hand and typically increase net income and equity depicted on the resulting financial statement.
In the next blog post, we will discuss another area where an accrual basis financial statement can help improve your company’s financial presentation to the surety.
This article is not intended as general tax advice. Readers are encouraged to seek separate tax counsel on all of these matters.