The cash basis of accounting records income as it is received and expenses as they are paid. The accrual method of accounting, on the other hand, recognizes income when it is earned and expenses when they are incurred, regardless of when the money actually changes hands. For most professional practices, the cash basis of accounting is the most practical approach and the most commonly used, and frankly, it’s the method of accounting that is most easily understood by practice owners. However, it can also lead to some pitfalls. Practices that don’t plan for retirement plan expenses, fixed asset purchases and other periodic payments can face an unwelcome surprise at the end of the year or the quarter.
3 Financial Statement Blind Spots
- Retirement plan contributions. Cash basis financial statements that do not include monthly accruals for retirement plan contributions can result in unrealistic compensation numbers for medical/dental providers. At a minimum, the CPA or bookkeeper should assist the practice with cash flow discipline by accruing retirement plan expenses throughout the year as the liability is incurred. This will allow owner/provider monthly compensation calculations to be based on reality. Also, by accruing the retirement plan contributions monthly, the annual retirement plan contributions will have been saved by year-end.
- Capital expenditures. Generally, purchases of fixed assets are recorded as assets on the balance sheet, and depreciation expense is recorded monthly or annually on the practice books for those fixed assets. However, depreciation will likely not accurately reflect the actual effect of the purchase of fixed assets on the cash flow of the practice, so professional practices need to determine the accounting entries that will most accurately reflect the effect on cash flow.For some practices, this method may simply be to record Section 179 expense (election to expense the cost of fixed asset purchases) as a journal entry in the month fixed assets are purchased. However, if there is uncertainty as to the availability of the Section 179 deduction or if fixed asset purchases are financed, an adjustment on the income allocation worksheets to reflect the monthly cash required for debt service may be the best way to reflect the effect of fixed assets on the cash flow of the practice.
- Expense allocation. Determining how to allocate costs to the owners/providers in your group is an issue that can make any practice manager’s hair turn grey. While there is no perfect professional compensation method, better information about your costs can help you and practice owners arrive at the most equitable approach. If your current financial statements don’t provide the level of detail you need about the costs that are being incurred and allocated to each provider in the professional compensation calculation, ask your CPA to help you set up a more detailed chart of accounts or prepare special reports from your accounting system.