Can someone explain the differences between how government does their accounting and how corporations must do theirs?
For instance how does a company deal with incurred obligations versus how the government does etc?
Also I’m wondering how or what system the government typically uses for accounting as a whole. Can’t believe it would be on an accrual basis because how do you account for income from children that aren’t born of children that aren’t born of children that aren’t born…well you get the picture.
As a company on accrual basis I have to report all income as it’s invoiced or even in process. Taxes are imposed on everyone in the future in perpetuity. If I could do this as a company my invoice would be infinite and thus my income would appear to be infinite. So they must be on a Cash in basis, but then how do they deal with incurred obligations?
I can’t answer that, but did you know that government agencies can’t commit to making payments more than one year in the future? That is because a current congress can not make obligations on future congresses. Of course they do things that will make those obligations, like take on debt, but the rule is they can’t. That is why the government can’t setup things like the X-prize to spark innovation unless the contest and the award are held in a short time period.
Both companies and the government operate on an accural basis. However, US, state, and local governments tend to use “fund” type accounting, in which specific, goal-oriented amounts of assets and liabilities that are treated independently of each other, almost as separate entities (i.e. “infrastructure”, “social security”, or “education”). By contrast, corporate accounting has one “fund” of assets for the company to use however they see fit. My understanding is that companies are allowed to use “estimates” a bit more liberally for valuation purposes as well.
Both types would incur obligations as they become apparent (when they get an invoice, bill, etc.). Other obligations may be valued via use of estimates and actuarial assumptions (most notably social security/medicare). You cannot, however, make estimates on future income (taxes, SS payments, etc.) unless it is pre-paid, in which you would gradually recognize income over the term of whatever service was paid for. This would be booked under “deferred revenue” as a liability (counter-intuitive, i know, but it makes sense in debit/credit terms). To book estimated future revenue as a receivable would violate the law of conservatism in accounting (underestimate assets/overestimate liabilities).
I don’t know if this answers your question but I hope it helps in your understanding.
Both companies and the government operate on an accural basis.
How does the government use accrual basis considering that the “Income” is endless? How is that accounted for?
In my experience I have to report all invoiced work as well as “Work in process” as “Received income” come tax time. At what point doe the government draw the line at “Work in process” where tax income is concerned?
To book estimated future revenue as a receivable would violate the law of conservatism in accounting (underestimate assets/overestimate liabilities).
But isn’t that exactly what accrual does? Invoice on money not received as well as work in progress are both “Future revenue”, particularly work in progress.
How does the government use accrual basis considering that the “Income” is endless? How is that accounted for?
The government can’t report income until it can be estimated and deemed as collectible. They don’t know this until the end of every pay cycle when payroll taxes are automatically calculated and paid to them. For them to accrue income in this sense is impractical as they would have to be able to 1) know how much every taxpayer makes each pay cycle and 2) create an accural for that as receivable. They likely don’t use an accrual for tax income becuase it would be totally cost ineffective. Any estimate on the day-to-day amount that any government is owed in personal and business payroll taxes would be completely off base and therefore violate accounting conservatism.
But isn’t that exactly what accrual does? Invoice on money not received as well as work in progress are both “Future revenue”, particularly work in progress.
Revenue is booked when invoiced, not when collected, under the accrual method. I can do “work in progress” all day long, but if I don’t bill a customer for it, its not income yet.
Government accounting varies between Federal and State & Local.
In general, without exploding your head, a few short years ago, changes were made to government accounting that requires them to keep track of their financials in:
GAAP - Accrual
GAAP - Cash
GASB - Modified Accrual
I’m not 100% positive on Federal agencies, but every State & Local produces 3 reports in the above accounting standards. The reason for this is that some genius wanted more GAAP accounting, but then they found out that they couldn’t get rid of fund, grant, and encumbrances accounting. Anyway, if you really want to know more, start by looking at a financial statement of a county or State or agency.
The government can’t report income until it can be estimated and deemed as collectible. They don’t know this until the end of every pay cycle when payroll taxes are automatically calculated and paid to them.
But wouldn’t this then be considered “Cash in” accounting and not accrual?
For them to accrue income in this sense is impractical as they would have to be able to 1) know how much every taxpayer makes each pay cycle and 2) create an accural for that as receivable. They likely don’t use an accrual for tax income becuase it would be totally cost ineffective. Any estimate on the day-to-day amount that any government is owed in personal and business payroll taxes would be completely off base and therefore violate accounting conservatism.
But that’s my point, they CAN’T use an accrual system on the income side because their “Income” is in essence infinite and completely in capable to be estimated.
Revenue is booked when invoiced, not when collected, under the accrual method.
Agreed.
**I can do “work in progress” all day long, but if I don’t bill a customer for it, its not income yet. **
I’ll have to ask my accountant how this works. Every year we are supposed to give an number for “Work in progress” and “Inventory”. I always assumed this was for tax purposes and they were accumulated as “Income”. So if you had a project that was 10K and it was 80% done you used that as 8K worth of income. Could be a wrong assumption on my part.
**But wouldn’t this then be considered “Cash in” accounting and not accrual? **
And
But that’s my point, they CAN’T use an accrual system on the income side because their “Income” is in essence infinite and completely in capable to be estimated.
It would be modified accrual as YaHey stated above. As regards tax collections, a cash approach to revenue recognition is the most accurate as the accrual method would wildly misstate income. For small private companies, they are allowed to use a “modified” accounting basis on their books if it serve to make their financial statements as transparent as possible.
**I’ll have to ask my accountant how this works. Every year we are supposed to give an number for “Work in progress” and “Inventory”. I always assumed this was for tax purposes and they were accumulated as “Income”. So if you had a project that was 10K and it was 80% done you used that as 8K worth of income. Could be a wrong assumption on my part. **
You most likely use a “percentage of completion” approach to recognizing revenue. This is most practical if you run a company in which preparing product or service to a customer spans a long period of time and/or is customized to any particular customer. This happens most with construction/architecture/engineering contracts. The purpose of it is to recognize an appropriate amount of “earned” income in an any fiscal period. For instance, if you agree to build a house for a customer (assume it will take 2 years to build) in year 1 and they pay you the full quote of the construction on day 1, year 1, you cannot recognize the full amount as revenue. If construction is 30% complete on the last day of year 1, you may then recognize 30% of the revenue on the project on those annual financial statments, and the remaining 70% in year 2 when the house is completed. For tax purposes, income on such contracts is recognized on a cash basis up until a certain amount (~$10M but not sure), and on a percentage of completion basis thereafter. To compute Alternative Minimum Tax (which I assume you do), percentage of completion is always used.