As you transition from a technology start-up to a more established business enterprise, there are many items you need to consider, not the least of which is accounting in accordance with generally accepted accounting procedures, or GAAP. Proper accounting is the backbone of accurate financial reporting and is usually a requirement from investors and lenders.
Proper accounting is the backbone of accurate financial reporting and is usually a requirement from investors and lenders.
Below is a listing of key items you shouldn’t overlook during this transition period:
- Revenue Recognition
The biggest issues pertaining to revenue recognition include:
- A lack of accounting policies.
- A lack of proper support and documentation.
- Manually prepared Excel schedules used to track projects, customers and services.
- Recognition of revenue that doesn’t correlate to the earnings process. For example, when services are provided and when the service/product is usable, or provides value to the customer.
- Loss contracts accounting timing. In situations where production costs exceed or are expected to exceed contract values, the entire loss on the contract is required to be recognized.
- Software development costs
Under GAAP, certain costs incurred to develop your website platform or software development projects should be capitalized and amortized over their estimated useful lives. In most cases, these capitalized costs can be deducted for tax purposes and qualify for R&D tax credits.
- Presentation of equity
You should ensure that equity balances and presentation of common and preferred stock, additional paid-in capital, unearned deferred compensation (if any), and retained earnings are in accordance with GAAP.
- Stock-based compensation
Under GAAP, such items are deemed to be equity instruments and as such should be fair valued as of the date of grant, and the fair value must be recorded as a compensation expense over the vesting period of the option grants.
- Warrants issued: Valuation & recording
Many companies issue warrants to external parties in conjunction with debt agreements or sales contracts. GAAP requires the fair value of these issuances to be calculated and recorded (expensed) as earned.
- Convertible debt
You should determine if convertible promissory notes include beneficial conversion features. A beneficial conversion feature arises when the conversion price of an instrument is below the per-share fair value of the underlying stock into which it converts. As a result, the conversion price is considered ‘in the money’ and the holder should realize a benefit to the extent of the price difference. Under GAAP, if the note included an embedded beneficial conversion feature, this benefit should be separately recognized and measured initially at its intrinsic value.
- Fixed assets: Recording GAAP vs. tax basis
During the start-up phase, you most likely tracked fixed assets and depreciation on a tax basis only out of necessity. However, GAAP doesn’t allow certain tax-specific allowances, such as section 179 and accelerated depreciation methods. You should separately track fixed assets for GAAP-purposes using an acceptable GAAP method. Most companies use the straight-line method of depreciation for book purposes.
- Accrued compensation
In our experience, many companies record commissions and compensated absences when they are paid to employees. However, GAAP requires commissions to be recorded and accrued when earned, regardless of when paid. In addition, a liability for amounts to be paid as a result of employees’ rights to compensated absences, such as vacation, illness, and holidays, shall be accrued in the period in which earned per GAAP.
- Deferred rent & tenant allowances
GAAP requires tenant allowances to be recognized as reductions of rental expense by the lessee on a straight-line basis over the term of the lease. In addition, if lease terms include escalating rental payments, GAAP requires monthly rental expenses also recognized on a straight-line basis over the term of the lease period.
- Subsequently issued credits
To ascertain the proper period for accounting, you should review and consider activity subsequent to year end, specifically credits posted to accounts receivable or debits posted to revenue. If these credits are related to current year services, you should record a reserve for the credits as of year-end.