Maybe peer pressure is making you want to hang with the cool kids on the GAAP side of the accounting fence. Or maybe it’s the taxman. Or your small business isn’t so small anymore, has outgrown cash accounting, you’re looking to sell, get a loan, or a seemingly endless list of solid reasons to convert from cash basis to accrual basis.

Whatever the case, converting to Generally Accepted Accounting Principles (GAAP) accounting is a significant step for a company or business owner, whether the move is forced upon you or specifically sought out. But for as many doors as a conversion to the accrual method can open for your business, it doesn’t come without hurdles and the need for a well-informed, organized approach.

Naturally, that’s where Embark shines, lending enormous value to your journey down the accrual accounting road with our specialized insights and vast, hands-on experience. So, on that note, use the following best practices and quick tips to help you get started on your conversion from cash accounting to GAAP accounting.

Why Are You Moving to Accrual Basis Accounting?

First of all, to get caught up in semantics for a bit, we must say the following – technically, speaking there’s no such thing as GAAP accounting. GAAP-compliant accounting, absolutely. But you won’t find a separate set of accounting rules devised by the good folks at the FASB.

The term GAAP accounting is synonymous with accrual accounting, the method approved by the FASB and, therefore, most of the financial world. And it’s that acceptance by the financial world that determines how thorough and consuming your conversion should be.

Put another way, if you’re converting to accrual accounting strictly because of an income tax requirement, the process likely won’t be as involved as one to shore up financial reporting to qualify for loans, entice investors, or push you towards the eventual sale of your company.

Obviously, the financial world needs an accurate picture with sufficient detail from an income statement, balance sheet, and cash flow statement, something cash accounting simply can’t provide. Further, such a thorough approach goes well beyond the mere basics that would typically appease the IRS for tax purposes.

In other words, your intentions with your business should guide how you proceed with your conversion to GAAP accounting which, at its heart, is essentially a data collection exercise. As you begin, we have a few key considerations and best practices to keep in mind.

• If an early goal is to sell your company or attract investment money, GAAP-compliant accounting records are a necessity. And the earlier you convert to accrual, the better. Converting from cash basis accounting after complex business transactions have already occurred makes the move to accrual that much more complicated and consuming for your bookkeeping or accounting people.
• Copy all of your statements before making any adjustments in your accounting system – QuickBooks or whatever else – in case you’re ever audited or need to reference them.
• After you convert, your GAAP books will be different from your tax books, but you file according to your tax accounting. Thus, be prepared to maintain two different sets of books, something very different than what the cash basis of accounting requires.
• Is your data a mess? Accounting software ancient or non-existent? Do you have boxes of random receipts sitting in an empty office somewhere? If so, perhaps converting to accrual should be a goal for the future. Attempting to convert to GAAP accounting with messy data is a recipe for stress and insomnia, especially for small business owners new to the terrain. In cases where the data is in bad enough shape, you can’t even convert from cash to accrual retrospectively. Instead, you might have to stick with cash for now and create monthly accrual financials as you go.
• Many cash-based companies operate with a lack of consideration on certain transactions. For instance, some businesses hand out equity like it's snack-sized candy bars on Halloween. So, to avoid getting too far out in front of your skis, work with a skilled CPA or specialist to see what the impact of such actions will be once you convert to the accrual-based method.
• The actual conversion process requires specific knowledge of GAAP accounting. If you don’t have a team in place that’s capable of properly performing the conversion, bring in outside help.

Pearls of Wisdom for Accrual Basis Accounting

While it's true that every company is different and will therefore have a unique conversion experience, that doesn't mean every move from cash to the accrual method of accounting is singular and without compare.

On that note, we suggest keeping a few specific areas in mind since they tend to be common when companies convert from cash accounting to GAAP accounting. Granted, they all won't apply to every entrepreneur, sole proprietor, or wide-eyed business person out there, but they can help you acclimate as you wade into the accrual accounting waters.

• Under cash accounting, recognition occurs upon receipt of payment. Under accrual accounting, revenue recognition occurs whenever you've completed your responsibilities to the client/customer, regardless of when you receive payment.
• It’s essential you record monthly accrual, deferral, and other adjusting journal entries before issuing monthly financial statements to stay on the good side of the GAAP gods.
• Be mindful of the useful life for fixed assets, and understand the many different ways the tax code allows you to depreciate assets.
• Payroll under accrual accounting carries new liabilities. Accrued balances in PTO and sick time, as well as salary crossing between pay periods, are all liabilities you must accrue.
• The regulatory environment you're in will affect what type of accruals you have to make, including workers comp taxes, and fees related to sales tax and property tax, amongst others.
• You must capitalize prepaid expenses for a good or service you’ll use in a future period. Insurance is the most common of these, but also be aware of prepayments for conferences, advertising, or membership/association fees.
• GAAP requires straight-line rent rather than the simple monthly payments typical under the cash basis method. Use a straight-line rent calculator to determine what to record, including any lease escalations.
• Debt will have some accrued interest. Also, pay attention to how you record any debt payments since many companies incorrectly expense the entire payment amount rather than applying part of it to the balance of the loan and expensing the interest portion
• You must accrue off-balance sheet liabilities or, put another way, anything that is an agreement for future obligations. For example, free rent for the first few months of a new lease is only free on the paperwork you sign. In your books, you must still expense the straight-line rent for those months, adjusted to accommodate the “free” months. The most common example of these liabilities is your accounts payable, where a liability is created if payment is not made when you incur an expense.
• Accounts receivable works in the same manner as accounts payable from an accrual perspective, so when you fulfill your obligation by delivering a good or providing a service, revenue is recognized at delivery, and the receivable is recorded. If the customer doesn't pay at that time, you still have an asset in your AR to show for it.

Obviously, this isn’t an exhaustive list but just a handful of the most common things to keep in mind as you go from the cash method of accounting to accrual basis accounting. To reiterate a previous point, the stakes are extraordinarily high when converting, so be certain you have access to sufficient experience and knowledge to ensure the cash to accrual conversion is silky smooth. If not, seek outside help before you start and save yourself an awful lot of time and heartache down the road. Of course, Embark will be here to provide guidance and insight whenever you need us.