Once again, it’s time for annual financial statements to be compiled, reviewed, or audited and presented to comply with bank covenants. Banks and investors generally require year-end financials to be in accordance with generally accepted accounting principles (GAAP). While GAAP requirements are geared to best serve investors as users of financial statements, many private company users include bankers and owners who care about cash flow and ability to repay debt.
When deciding whether to employ income tax basis financial statements or GAAP, there are some key differences to consider. The basis of accounting will change based on your auditor’s opinion, but the type of opinion will stay the same. For the restaurant industry, differences between the two approaches are most noticeable with:
Lease accounting
Tenant improvement allowance
Gift card recognition
Depreciation and amortization
Impairment
Purchase accounting
For example, the income tax basis of accounting requires the recognition of rent based on what is paid or is to be paid. Conversely, GAAP generally requires recognition of rent expense on a straight-line basis (not cash basis) over the lease term, a right-of-use asset and a lease liability. Determining the amounts of right-of-use asset and lease liability requires a thorough understanding of technical literature. For more details, see BDO's Blueprint “Accounting for Leases Under ASC 842”.
If you’re leaning toward income tax basis of accounting, a few benefits to consider include:
A review or audit can be less expensive for clients and easier to prep for, as less accounting assistance is needed from the CPA firm
Results are often better aligned with EBITDA as it excludes non-cash transactions and focuses on the cash outflow as well as the ability to meet debt servicing requirements
The P&L results better reflect the operating cash flow of the company by excluding non-cash transactions for continuing operations
It has minimal impact on sales, cost of sales, labor
The balance sheet will only include liabilities with cash outlay requirements
On the other hand,
Results of income tax basis accounting will not include adjustments for impairment or closure of stores; however, disclosures will be made in the notes to financial statements
Re-evaluation of debt covenants may be necessary; some banks allow for the non-cash element of lease accounting to be backed out of calculations
In many private equity deals, GAAP financial statements are preferred
Choosing between income tax basis accounting and GAAP depends on your restaurant's financial reporting needs, lender requirements, growth plans, and stakeholder expectations. BDO's Restaurant Practice can help you evaluate the advantages and implications of each approach and identify the accounting framework that best supports your business objectives.