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While it may have a reputation for being a
somewhat monotonous industry, accounting
can become surprisingly abstract and
subjective without a standard set of rules
to follow. Every accountant technically
has the ability to assign value or categorize
expenses in a slightly different way. As
you can imagine, if there was no code of
conduct, this could cause utter anarchy!

GAAP to the rescue!

GAAP, or generally accepted accounting principles,
is essentially the Magna Carta of accounting in the
United States and establishes the standard financial
reporting definitions and styles that are uniform across
all businesses. If you’re a banker, auditor, accountant,
or CPA these are the rules you play by, and luckily,
because every accounting and finance professional
agrees to use GAAP, businesses can be measured by
the same yardstick. This creates a more level playing
field for everyone.employees for long.

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Why GAAP matters When You Should
to your business Use GAAP
Without a firm stake in the ground, deciphering a
business’ finances or comparing one business to Any publicly traded company in the United
another would be extremely complicated. If bankers, States is required by law to report their
venture capitalists, and auditors can’t make out what
financials using GAAP. This is so any outside
your reported figures stand for, it will be virtually
impossible for them to give you loans, confidently individuals who aren’t familiar with the
invest in your company, or verify your tax information. business can still decisively trade stocks.

Other milestones that indicate when a

company should start using GAAP include
but are not limited to:
Startups are not required to adhere
to GAAP until they grow to more than

• Series A funding
• Annual audits
$5 million in annual sales or inventory • Board meeting presentations
worth more than $1 million each year. to current investors

Startups and smaller businesses are able

to choose between the cash and accrual
methods but are not required to adhere
to GAAP until they grow to more than
$5 million in annual sales or inventory
worth more than $1 million each year.
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GAAP (or Accrual) vs. Cash Example:
To understand GAAP you need to be familiar with Say you run an online dating website and you
the two methods used for reporting finances: cash allow customers to purchase subscriptions for one
and accrual. In cash accounting, expenses and flat rate annually (instead of month to month).
income are recorded as the actual money comes
in and goes out of your bank. On the other hand,
If you are using the cash method for your
accrual accounting records these sales or services as
they are earned, spent, or performed, whether actual accounting, each payment would only appear as
payments are received or not. income once a year in a single lump sum from the
month the subscriber purchased their membership.

If you are using the accrual method for your

accounting each subscription would break that
annual amount into monthly (or even daily, hourly,
minute-to-minute, second-to-second) increments
that align with your services throughout the year.

Both methods provide a lot of wiggle room for

creative accountants–especially with the accrual
method. In an effort to build more structure around
this practice, auditors established a list of principles,
assumptions, and constraints and GAAP was born.
As a form of accrual accounting, GAAP reports all
transactions when they are earned, used, or due
instead of when payment is procured and follows
guidelines to ensure uniformity.
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Some differentiators in GAAP
There are assumptions, principles, and constraints  Reports should be as conservative as possible
that go along with GAAP method: and assume less favorable situations and
underreported figures. For example, our
 One can safely assume that a company dating site would have to wait to record their
using GAAP is an independent, long-term subscriptions from a promo until they actually
business entity that operates on a widely occur but would record any lost customers at the
accepted currency. earliest time they can be assumed, even if they
had a 30 day cancellation policy.
 Accountants must prepare each financial
statement using impartial evidence to keep  Accountants must prepare each financial
figures as unbiased as possible. statement using impartial evidence to keep
figures as unbiased as possible.
 They must focus on only releasing information
that is relevant to making decisions and  When preparing reports, accountants
judgments about the company. should only report specific products, items,
etc. if they are significant enough to influence
 Unlike other accounting methods,
decision makers.
companies using GAAP must keep their
methods and principles consistent every  To provide a more direct picture of profitability
time they report in order to show accurate and performance accountants focus on
financial patterns over time. establishing a correlation between the cost of
products purchased and the revenue of goods
that get sold.

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Business benefits of GAAP
If you’re reading this article, you’re probably a GAAP/Accrual recognizes transactions in real-time
business owner, not an accountant, and are less so they can be handled in real-time. This way tasks
interested in the definitions of cash, accrual, and are less likely to fall by the wayside because you
GAAP. You’d probably rather be focusing on the can handle them as they happen instead of waiting
value your business can get from each method. around to be paid.
The major distinguishing advantage of accrual
and GAAP over cash accounting all comes down GAAP provides a more accurate understanding
to one thing: timing. of what you owe and what you own and can match
your expenses to the revenue it will earn. By forcing
In cash all you can recognize is what you receive, you to question why you’re not hitting expectations,
when you receive it. This can put you at risk accrual can even help you diagnose issues such as
for forgetting things like settling your accounts gaps in earning capabilities, collection issues, etc.
receivable, recognizing interest income, etc.
By comparison, GAAP/accrual is almost like
Cash doesn’t help your investors. While you can a crystal ball for strategizing and provides a more
do more to manipulate your accounting with the accurate picture of your revenue and identify and
cash method, it lacks to ability to recognize the costs predict cash flow trends. Being able to anticipate
you’ve accrued, which investors will want to know. your finances for the future provides invaluable
information for building out your business model
When using cash you’re subject to other people’s or planning for department operations.
unpredictable behaviors and actions so there’s no
way to be absolutely sure what you can expect to
come or when.

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GAAP tax implications
Everybody’s taxes are like snowflakes, each one is
unique and needs to be handled on a case by case
basis. As a viable business, you pay taxes each year
based on your net profit revenue. Because you have
a different objective when preparing your tax return
than your accounting statement, you could have
another strategy to consider when choosing
an accounting method.

With cash accounting you are responsible for paying

taxes on all income when it is received. If we look
at the dating site example, when a subscriber signs
up on November 1st that income is taxable for that
entire year–even though there are only two months
of a subscription used.

The IRS sets a threshold for the total sales and

So while you will want to prepare your accounting
revenue a C corporation can reach before they
to present the most honest and healthy outlook on
are required to file their taxes under accrual. With
your profitable income, your tax strategy will rely
GAAP/accrual, our dating site would only account
on what responsibilities and deductions you qualify
their November subscriber as income for those
for. Simply put, if you have the choice–don’t have to
two months that year–and would continue to
worry about IRS regulations–it boils down to when
regard that as income earned/service provided
you want to claim responsibility for your earnings
on taxable statements over the following ten
and what will be the most optimal time to do it.
months in the next year.

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We can provide GAAP accounting services to any
of our customers who require it and you’ll save
time and money with prices that are affordable
and tailored to suit your business needs.

By implementing inDinero’s Enterprise
(aka Outsourced Controller) offering TODAY TO GET STARTED!
you wouldn’t need to have read
through this document AT ALL!
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