Special-Purpose Frameworks
Not all financial statements are prepared in accordance with U.S. GAAP or IFRS. Many entities — particularly smaller businesses, government contractors, and regulated industries — prepare financial statements using a special-purpose framework (SPF). These frameworks include the cash basis, tax basis, regulatory basis, contractual basis, and other bases of accounting. Auditors must understand the unique reporting requirements that apply when opining on financial statements prepared under a special-purpose framework.
This section covers the definition and types of special-purpose frameworks, the requirements under AU-C 800, factors to consider when reporting, report modifications, alert paragraphs that restrict use, and how special-purpose framework reporting compares to GAAP-basis reporting.
Definition of Special-Purpose Frameworks
A special-purpose framework is a financial reporting framework other than GAAP that is one of the following:
| Framework | Description | Common Users |
|---|---|---|
| Cash basis | Revenue is recognized when cash is received; expenses are recognized when cash is paid | Small businesses, sole proprietors |
| Tax basis | Financial statements are prepared using the basis of accounting used for income tax returns (IRC) | Partnerships, S corporations, small businesses |
| Regulatory basis | Financial statements are prepared in accordance with a financial reporting framework established by a government regulatory agency | Insurance companies, utilities, banks |
| Contractual basis | Financial statements are prepared in accordance with the financial reporting provisions of a contract or agreement | Entities with specific lender or investor agreements |
| Other basis | A definite set of logical, reasonable criteria applied to all material items (e.g., price-level adjusted financial statements) | Specialized situations |
The term "Other Comprehensive Basis of Accounting" (OCBOA) was previously used to describe these frameworks. Under current AICPA standards, the preferred term is special-purpose framework. However, you may still see OCBOA referenced in older materials and on the CPA exam.
Cash Basis
Under the cash basis of accounting, transactions are recorded only when cash changes hands:
- Revenue is recognized when cash is received (not when earned)
- Expenses are recognized when cash is paid (not when incurred)
- Accruals, prepayments, and deferrals are generally not recorded
Modified Cash Basis
Many entities use a modified cash basis, which is the cash basis with certain modifications that have substantial support (e.g., capitalizing and depreciating fixed assets, recording long-term debt). The modifications must be logical and reasonable.
Example: Gies Co. (a small consulting firm) prepares its financial statements on the cash basis. Revenue of 620,000 are reported based on cash disbursements. Accounts receivable and accounts payable do not appear on the statement of assets and liabilities.
On the CPA exam, remember that cash-basis financial statements use different titles than GAAP financial statements. Instead of a "Balance Sheet," the entity presents a "Statement of Assets and Liabilities Arising from Cash Transactions." Instead of an "Income Statement," it presents a "Statement of Revenue Collected and Expenses Paid."
Tax Basis
Under the tax basis of accounting, financial statements are prepared using the same rules the entity follows for its income tax return:
- Revenue is recognized according to tax rules (which may differ from GAAP)
- Expenses are deducted according to tax deductibility rules
- Depreciation follows tax methods (e.g., MACRS) rather than GAAP methods (e.g., straight-line)
- Items like tax-exempt income or non-deductible expenses are treated per the Internal Revenue Code
Example: Bear Co. prepares its financial statements on the tax basis. Depreciation expense is 280,000 that would have been reported under GAAP (straight-line). The financial statements include a note explaining the basis of accounting and how it differs from GAAP.
Common Differences Between Tax Basis and GAAP
| Item | Tax Basis Treatment | GAAP Treatment |
|---|---|---|
| Depreciation | MACRS / Section 179 / Bonus depreciation | Straight-line or other systematic method |
| Revenue recognition | Per IRC rules (may use completed contract, installment method) | ASC 606 (performance obligations) |
| Inventory | LIFO permitted without LIFO conformity issues | LIFO, FIFO, weighted average (with specific impairment rules) |
| Bad debts | Direct write-off method | Allowance method (expected credit losses under ASC 326) |
| Lease accounting | May differ from ASC 842 | Right-of-use assets and lease liabilities |
Regulatory Basis
Financial statements prepared on a regulatory basis follow rules established by a government regulatory agency:
- Common in insurance, banking, utilities, and other regulated industries
- The regulatory framework may differ significantly from GAAP
- The financial statements are intended to meet the regulatory agency's reporting requirements
Example: Kingfisher Industries (an insurance company) prepares financial statements on a statutory basis as required by the state insurance commissioner. Statutory accounting principles differ from GAAP in areas such as the valuation of investments, recognition of premiums, and treatment of deferred acquisition costs.
General-Use vs. Restricted-Use Reports
| Scenario | Report Type |
|---|---|
| Regulatory basis financial statements are intended for general use (i.e., the framework is widely understood and provides useful information for a broad range of users) | General-use report — no restriction on use |
| Regulatory basis financial statements are intended only for filing with the regulatory agency | Restricted-use report — an alert paragraph is included to restrict distribution |
Contractual Basis
Financial statements prepared on a contractual basis follow the financial reporting provisions specified in a contract or agreement:
- Common in loan agreements, partnership agreements, and joint venture contracts
- The reporting framework is tailored to the needs of the contracting parties
- These financial statements are always restricted-use because they are meaningful only to the parties to the contract
Example: MAS Inc. has a loan agreement with First National Bank that requires annual financial statements prepared using specific accounting methods defined in the loan covenant (e.g., capitalizing all leases, excluding non-recurring items from EBITDA). The auditor reports on these financial statements under the contractual basis.
Financial statements prepared on a contractual basis are always restricted-use. The auditor's report must include an alert paragraph that restricts the use of the report to the parties to the contract.
AU-C 800 Requirements
AU-C 800 governs audits of financial statements prepared in accordance with special-purpose frameworks. Key requirements include:
Acceptance and Planning
| Requirement | Details |
|---|---|
| Acceptability of framework | The auditor must determine that the special-purpose framework is acceptable for the engagement |
| Engagement letter | Must specify the framework and identify any supplemental disclosures required |
| Understanding with management | Management must acknowledge responsibility for the financial statements and the adequacy of disclosures |
Disclosures
Even under a special-purpose framework, the entity must include disclosures that are:
- Informative — sufficient for users to understand the basis of accounting
- Comparable — describing how the special-purpose framework differs from GAAP (this is required for cash, tax, and regulatory basis frameworks)
- Adequate — addressing all matters that are essential to the fair presentation of the financial statements under the special-purpose framework
The financial statements must include a note describing the basis of accounting and how it differs from GAAP. This is sometimes called the "summary of significant accounting policies" note, and it is critical for special-purpose framework financial statements.
Reporting on Special-Purpose Framework Financial Statements
Report Elements
The auditor's report on special-purpose framework financial statements includes all the standard elements of an audit report, plus the following additional elements:
| Element | Purpose |
|---|---|
| Description of the framework | The report must describe the special-purpose framework used (e.g., "income tax basis of accounting") |
| Reference to the note | The report refers to the note in the financial statements that describes the basis of accounting |
| Opinion wording | The opinion states that the financial statements present fairly, in all material respects, in accordance with the [specific special-purpose framework] — not "in accordance with GAAP" |
| Alert paragraph (if applicable) | For regulatory and contractual basis frameworks, an alert paragraph restricts the use of the report |
Financial Statement Titles
Special-purpose framework financial statements should use titles that distinguish them from GAAP financial statements:
| GAAP Title | Special-Purpose Framework Title (Examples) |
|---|---|
| Balance Sheet / Statement of Financial Position | Statement of Assets and Liabilities — Tax Basis |
| Income Statement | Statement of Revenue and Expenses — Income Tax Basis |
| Statement of Cash Flows | Statement of Cash Receipts and Disbursements |
| Balance Sheet | Statement of Assets and Liabilities Arising from Cash Transactions |
Example: Illini Entertainment prepares its financial statements on the income tax basis of accounting. The financial statements are titled "Statement of Assets, Liabilities, and Equity — Income Tax Basis" and "Statement of Revenue and Expenses — Income Tax Basis." The auditor's report states: "In our opinion, the financial statements present fairly, in all material respects, the assets, liabilities, and equity of Illini Entertainment as of December 31, 2025, and its revenue and expenses for the year then ended, in accordance with the income tax basis of accounting described in Note 1."
Alert Paragraph — Restricting Use
For certain special-purpose frameworks, the auditor must include an alert paragraph that restricts the use of the report:
| Framework | Alert Paragraph Required? | Reason |
|---|---|---|
| Cash basis | No | Generally understandable by a wide range of users |
| Tax basis | No | Generally understandable by a wide range of users |
| Regulatory basis (general use) | No | Framework is widely understood |
| Regulatory basis (restricted use) | Yes | Financial statements are intended only for the regulatory agency |
| Contractual basis | Yes | Financial statements are meaningful only to the contracting parties |
| Other basis | Depends | Based on whether the financial statements are intended for general or restricted use |
Content of the Alert Paragraph
The alert paragraph states that:
- The financial statements are prepared in accordance with [specific framework]
- The financial statements are not intended to be presented in accordance with GAAP
- The report is intended solely for the specified parties (e.g., the regulatory agency or the contracting parties)
- The report is not intended for anyone other than the specified parties
Even though the report includes a restriction on use, there is nothing the auditor can do to prevent the report from being distributed to other parties. The restriction is a notification, not a legal prohibition. However, including the alert paragraph limits the auditor's responsibility to the specified parties.
Example: BIF Partners prepares financial statements under the terms of its partnership agreement (contractual basis). The auditor's report includes an alert paragraph:
This report is intended solely for the information and use of the partners of BIF Partners and First National Bank and is not intended to be and should not be used by anyone other than these specified parties.
Comparison with GAAP-Basis Reporting
| Feature | GAAP-Basis Report | Special-Purpose Framework Report |
|---|---|---|
| Opinion reference | "In accordance with accounting principles generally accepted in the United States of America" | "In accordance with [specific framework]" (e.g., income tax basis, cash basis) |
| Financial statement titles | Standard titles (Balance Sheet, Income Statement, etc.) | Descriptive titles indicating the framework |
| Disclosure of basis differences | Not applicable — GAAP is the standard | Required note describing the framework and how it differs from GAAP |
| Alert paragraph | Not included | Required for regulatory (restricted-use) and contractual basis |
| User restriction | None — report is general use | May be restricted to specified parties |
| Supplementary GAAP disclosures | Required by GAAP | Not required but may be included; if included, the auditor considers whether they are appropriate |
Common Special-Purpose Framework Engagements
Small Business Tax-Basis Engagement
Scenario: Illini Security (a small private security firm) prepares its financial statements on the income tax basis because its primary users are the owners and the IRS. The auditor:
- Accepts the engagement, confirming the tax basis is an acceptable framework
- Plans the audit using the same risk-based approach as a GAAP audit
- Tests revenue, expenses, and balances using the tax basis criteria
- Evaluates the adequacy of disclosures, including the note describing how the tax basis differs from GAAP
- Issues a report stating the financial statements present fairly in accordance with the income tax basis of accounting
Regulatory-Basis Insurance Company
Scenario: Kingfisher Industries (an insurance company) prepares statutory financial statements for filing with the state insurance department. The auditor:
- Evaluates the statutory accounting principles as the applicable framework
- Tests the financial statements against the regulatory requirements
- Determines that the statements are intended solely for regulatory filing (restricted use)
- Issues a report with an alert paragraph restricting use to the insurance department and management
Contractual-Basis Loan Agreement
Scenario: MAS Inc. has a loan agreement requiring financial statements prepared using specific covenants defined in the loan contract. The auditor:
- Reviews the contract terms to understand the required basis of accounting
- Tests compliance with the contractual reporting provisions
- Issues a report with an alert paragraph restricting use to MAS Inc., the lender, and their respective legal counsel
- The opinion states the financial statements present fairly in accordance with the financial reporting provisions of the loan agreement
Summary
| Concept | Key Points |
|---|---|
| Special-purpose frameworks | Cash basis, tax basis, regulatory basis, contractual basis, other basis |
| AU-C 800 | AICPA standard governing audits of special-purpose framework financial statements |
| Cash basis | Revenue when received, expenses when paid; no accruals |
| Tax basis | Follows income tax return rules (IRC); MACRS depreciation, direct write-off method |
| Regulatory basis | Rules set by a government regulatory agency; may be general or restricted use |
| Contractual basis | Follows terms of a contract or agreement; always restricted use |
| Financial statement titles | Must differ from GAAP titles to avoid confusion |
| Disclosure requirements | Must describe the framework and how it differs from GAAP |
| Alert paragraph | Required for regulatory (restricted-use) and contractual basis reports |
| Opinion wording | "In accordance with [specific framework]" — never references GAAP |
| GAAP comparison | Special-purpose framework reports require additional description, may be restricted use, and use distinct titles |
| OCBOA | Former term for special-purpose frameworks; still seen in older materials |