Small business accounting software records transactions well and records judgments poorly. A ledger kept in QuickBooks Online or Desktop will usually be accurate on cash and on transactions entered, and silent on items that GAAP requires management to estimate: accruals, deferrals, impairments, leases, deferred taxes and disclosures. Converting the ledger to GAAP statements is largely a matter of adding those judgments and documenting them. For the audit-side view see auditing a client on QuickBooks Online and QuickBooks cleanup before the audit.
Start with the basis of accounting
The SBA notes that GAAP is the standard the accrual method follows and that private companies are not required to follow it. A client asked for GAAP statements by a lender, an investor or an auditor needs accrual books first. A client that records on a cash or tax basis needs the conversion described in converting cash-basis books to accrual. Other frameworks exist for clients that do not need GAAP. See cash and tax-basis financial statements.
What the ledger usually misses
| Area | What to examine | Topic reference |
|---|---|---|
| Revenue | Contracts, performance obligations, timing, deferred revenue, variable consideration | ASC 606, deferred revenue schedule |
| Receivables | Allowance for expected credit losses | ASC 326 trade receivables |
| Inventory | Costing method, cost flow, lower of cost and net realizable value, counts | inventory costing |
| Prepaids and accruals | Expenses paid in advance, unpaid wages, bonuses, interest, utilities | accrued expenses |
| Fixed assets | Capitalization, depreciation, disposals, impairment | PP&E |
| Leases | Right-of-use assets and lease liabilities | ASC 842 |
| Debt | Classification, issuance costs, accrued interest, covenants | ASC 470 |
| Equity | Stock compensation, distributions, owner activity | ASC 718 |
| Income taxes | Current and deferred taxes, uncertain positions | ASC 740 |
| Contingencies and subsequent events | Litigation, guarantees, events after year end | ASC 450, subsequent events |
| Disclosures | Policies, related parties, concentrations, going concern | GAAP principles |
Treat the table as a checklist. For each row, record whether it applies, the amount and the evidence.
Where to record the adjustments
Two approaches work:
- Post to the ledger. Enter adjusting entries in the accounting file at period end and lock the period. The ledger then matches the statements.
- Top-side entries. Keep the ledger as the client's record and carry GAAP adjustments in a separate workbook that starts from the trial balance. Statements are produced from the adjusted trial balance.
The second approach keeps the client's file simple and the adjustments visible, and it needs a rollforward each period so reversing items do not double count. See adjusted trial balance worksheet guide and adjusted trial balance with AJE and RJE columns. Whichever approach is chosen, state it in the file and do not mix them in the same year.
Support for each adjustment
- Calculation. A workbook that a reviewer can reperform.
- Source documents. Contracts, invoices, bank and lender statements, payroll reports and counts.
- Basis. The accounting policy and the standard it follows.
- Approval. Management's review and approval, dated.
Estimates need extra documentation: method, inputs, data source and reasonableness check. See auditing accounting estimates.
Conversion procedure
- Reconcile the starting trial balance. Cash, subledgers and debt tie to external statements. Clean up first. See catch-up bookkeeping and cleanup.
- Map accounts to statement lines. See chart of accounts design.
- Run the checklist above. One adjustment schedule per row.
- Post or record adjustments. Using one approach consistently.
- Prepare statements and notes. From the adjusted balances.
- Roll forward. Carry the adjustments into the next period's opening position and reverse what should reverse.
- Tick and tie. Check statements to the trial balance and the notes to the statements. See tick and tie.
Software features that help and where they stop
Accounting platforms can hold recurring entries, closing dates, audit logs, classes and attachments. Each of these supports the process, and none replaces the judgment. An audit log shows who changed an entry, and it does not say whether the entry was right. Use the closing date and log for control and keep judgments in the supporting workbooks.
Who does what
The client owns the ledger and the judgments in it. The firm assembles the adjustment schedules, proposes entries and explains the reasoning, and management reviews and approves each one in writing. For an attest client, that division of responsibility is what keeps the work a nonattest service rather than management's own decision-making. State it in the engagement letter and keep the approvals with the schedules. A short monthly or quarterly meeting where management walks through the estimates, such as the allowance and the accruals, builds the ownership that the auditor will look for.
Common problems
- Revenue recorded when invoiced even though service periods extend beyond year end.
- No allowance for credit losses on old receivables.
- Capital purchases expensed because the tax policy was used.
- Leases and their disclosures omitted.
- Owner transactions mixed with business expenses.
- Different treatments in the monthly statements and the year-end statements.
FAQ
Do all clients need GAAP?
No. The SBA notes private companies are not required to follow GAAP. The need comes from lenders, investors, regulators or the audit.
Is a QuickBooks file auditable?
Yes, with adequate support and controls. See the audit article linked above.
Should adjustments be posted to the ledger?
Either approach can work if it is consistent and documented.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- SBA, Manage your finances: https://www.sba.gov/business-guide/manage-your-business/manage-your-finances
- IRS, Publication 538, Accounting Periods and Methods: https://www.irs.gov/publications/p538
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