US GAAP, explained simply
Many smaller private companies do not follow GAAP fully. Diligence adjusts their records to a GAAP-like basis so that periods and companies can be compared, and so that the definitions in the purchase agreement can be applied.
Purchase agreements typically refer to GAAP “applied consistently” with the methods used in the reference financial statements.
ASC topics that recur in diligence
ReferenceOther bases of accounting
- Cash basis: records income and costs when money moves
- Tax basis: follows income tax rules
- IFRS: international standards used in many countries outside the US
Worked example
Riverbend HVAC keeps its books on a tax basis. It expenses all small equipment immediately and records revenue when invoiced. Diligence restates two years to an accrual and GAAP-like basis, matching revenue to completed jobs and depreciating equipment over its useful life. The restated results show steadier profit and a clearer trend.
Riverbend HVAC Services is a fictional company. All figures are illustrative.
Why it matters in a deal
Price, working capital and debt definitions in a US purchase agreement usually refer to GAAP applied consistently. Without a common basis, figures cannot be compared or agreed.
Red flags
- Accounting policies that change between years
- “GAAP” claimed without accruals or reserves
- Different bases used for different periods