What does contractual basis mean on the CPA exam?
Last reviewed
Contractual basis. A special-purpose framework built from the terms of a contract, used when two parties agree how the numbers will be prepared for their own purposes.
Defined against AU-C 800.07.
Worked example
A lender's loan agreement requires the borrower to deliver annual statements prepared under rules written into the agreement: inventory at cost with no write-downs, and leases kept off the balance sheet. The borrower engages an auditor to report on those statements for the lender.
What must the auditor's report include, and who may rely on it?
- The agreement's rules are a special purpose framework, a contractual basis, so the auditor first judges whether the framework is acceptable and whether the statements describe it adequately, including any significant interpretations of the contract.
- The report carries an emphasis-of-matter paragraph saying the statements follow the contractual basis, pointing to the note that describes it, and stating that this basis differs from GAAP.
- Because the basis comes from a contract between two parties, the report also carries an alert restricting its use to those parties, here the borrower and the lender.
Answer: An emphasis-of-matter paragraph describing the contractual basis, and an alert that limits use of the report to the borrower and the lender.
The trap: Treating it like cash-basis or tax-basis statements, which may be issued for general use. A contractual basis is one of only two special purpose frameworks whose report must be restricted, the other being a regulatory basis not meant for general use.
Based on AU-C 800.07; AU-C 800.16; AU-C 800.20.
Which CPA exam sections use contractual basis?
Contractual basis appears in the FAR section of the CPA exam.
Other terms defined against AU-C 800
- cash basis: Recognizing revenue when cash is received and expense when cash is paid.
- regulatory basis: A special-purpose framework required by a regulator, such as an insurance department's rules.
Related terms
- applicable financial reporting framework: The framework management adopts for the statements, such as GAAP or a special purpose framework.
- adjusted basis: What the taxpayer has invested in property for tax purposes: cost, plus improvements, less depreciation taken.
- stock basis: A shareholder's investment in S corporation stock for tax purposes.
- tax basis: What an asset or liability is worth for tax purposes, which is often not what it is worth for accounting.
- basis of accounting: The rule for WHEN something is recorded: cash when money moves, accrual when it is earned or incurred, modified accrual somewhere between.
- carryover basis: Basis that follows the property from the previous owner instead of resetting to what was paid.