Cash Basis Accounting

Part of the problem that worker cooperatives face is an accounting system that is built under the flawed assumptions of modern finance. Under Generally Accepted Accounting Principles (GAAP) there are two methods that are used for reporting, cash basis and accrual accounting. The use of cash basis accounting is limited to small businesses who can choose which method to use.

Accrual accounting causes worker cooperatives to conduct transactions such as patronage distributions and member buy-outs, based on future events that have not yet occurred. This can result in over payment in cases where the assumed events do not happen as expected.

Cash Basis, Accrual, or Both?

For most businesses the stated earnings and assets will be higher based on accrual accounting than cash basis accounting. Cash basis accounting will typically be the more conservative statement of the condition of the business. There can be exceptions where cash basis accounting is less conservative. For example, when there is a large volume of unpaid invoices (which will not show up on the balance sheet), or when a lot of inventory is advanced to the firm (which shows up as an asset of the firm).

The timing of transactions matter in a worker cooperative because patronage (earnings) payments and internal capital account payouts from member departure depend on the current state of the cooperative. It is therefore important that the accounting methodology accurately reflect the current state and not include assumptions about future performance.

Since cash basis accounting provides an accurate statement of the current assets of the coop it should be used for transactions involving investments and earnings. A departing member should be paid out based on what already transpired, not what is expected to happen. This will prevent losses from being transferred between coop members without cause.

However, a number of decisions will be made by current members that will not have an impact until after they leave. For example the decision to purchase of inventory which is expected to be sold after a member leaves. In this case accrual accounting provides a view of what is expected to happen.

The solution is to distribute patronage or pay out departing members in the current period based on cash basis accounting, but give them future claim based on the difference between the cash basis and accrual accounting value. That future claim will be paid if and when the events assumed under accrual accounting transpire. And if the events do not take place that future claim is lost.

In the case where the cash basis value is larger than the accrual value, the accrual value should be used with no future claim to the member.

This would be useful in situations such as the collapse of the dot com bubble, when many invoices from internet companies ended up not being paid. This payout solution would prevent members of a worker cooperative from being paid patronage (or their buy out) based on the assumption that those invoices would result in payments. They would only receive additional compensation once those payments came through.

The initial cash basis transaction plus deferred accrual claim will prevent losses from being transferred between members unfairly during routine transactions. It will also alleviate the time horizon problem cause by member planning to departure who will not want to make decisions that might increase long term earnings if there is no (or negative) immediate effect.

Accounting Summary

To modify the accounting so it is suitable for worker cooperatives:

  • Eliminate intangible and fictitious assets from the balance sheet.
  • Value all assets at their fair market value (No accounting cost principle, no held to maturity)
  • Conduct transactions based on cash basis accounting with at potential future claim based on accrual accounting.

The proposed solution outlined above is a bit of a hack using the available accounting tools. The larger problem of properly compensating members for decisions that may be good or bad, and perhaps later modified, is not trivial. This if further complicated when with the future implementation can be effective or ineffective. Attempting to solve that issue will require a substantialĀ rebuilding of accounting model under a different set of assumptions. That will be a major task, and likely one that is of interest to the broader coop community.