Abstract
This paper explains the trade-offs between the relevance and faithful representation of accounting information analyzed in the contexts of the cash-basis, accrual-basis, and fair value accounting methods used to prepare financial statements for Generally Accepted Accounting Principles (GAAP) and tax reporting. Discussion of the role of the relevance and faithful representation of accounting information is generally separate from any discussion of the trade-offs between cash-basis, accrual-basis, and fair value accounting methods, and the different needs and priorities of the users of GAAP and tax reporting information. The study contributes to the literature by suggesting how the importance of relevance and faithful representation differs between GAAP reporting and tax reporting, and how the allowable accounting methods for GAAP and tax reporting align with the differing emphasis on relevance and faithful representation. We review the reporting requirements established by regulators in light of these trade-offs and discuss how the needs of external users of the reporting information shape the allowable accounting methods for GAAP and tax reporting. Key words: Relevance, faithful representation, cash-basis, accrual-basis, fair value, GAAP, tax reporting.
Highlights
The purpose of this paper is to discuss the trade-offs inherent in three competing financial reporting systems cash-basis accounting, accrual-basis accounting, and fair value accounting - and the implications of the trade-offs in light of the requirements established for GAAP and tax reporting
The accounting information prepared for GAAP and tax reporting is presumed to be useful for external users
Relying on the idea that financial markets are efficient and that prevailing prices are reliable measures of value most relevant to financial statement users, regulators continue to allow companies to use fair value accounting for reporting a specific set of assets, including certain financial assets and liabilities, asset retirement obligations, derivatives and intangible assets acquired in a business combination (Chung et al, 2016)
Summary
The purpose of this paper is to discuss the trade-offs inherent in three competing financial reporting systems cash-basis accounting, accrual-basis accounting, and fair value accounting - and the implications of the trade-offs in light of the requirements established for GAAP (financial) and tax reporting. Knowledge, this study is the first to demonstrate how the importance of relevance and faithful representation differs between GAAP and tax reporting, and how the allowable accounting methods emphasize the different needs and priorities of the users of accounting information. Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) states that the primary objective of financial reporting is to provide financial information that is useful to investors and creditors for making investment and lending decisions. Accounting information is considered relevant if it would make a difference in a business decision. For such information to be relevant, it must possess predictive value (providing accurate expectations about the future) or confirmatory value (confirming or correcting prior expectations). Accounting information has faithful representation if it accurately depicts the actual events that occurred, including providing information that is complete (without important omissions), neutral (not biased), free from error, and verifiable
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