Difference Between GAAP and 704 B

Edited by Diffzy | Updated on: April 30, 2023


Difference Between GAAP and 704 B

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It is essential for companies to have a fundamental understanding of accounting for their transactions, regardless of whether they are managed as sole proprietorships, corporations, or partnerships, in order for operations to function efficiently. If you are not familiar with the proper procedures for keeping these records, it may be difficult to deliver information to the many stakeholders in your company.

When a company's books are kept in accordance with Generally Accepted Accounting Principles (GAAP), the transactions that occur inside the company are often documented in accordance with the regulations that have been established by the financial accounting board. On the other hand, transactions are often documented in accordance with the code of the Internal Revenue Service for the purpose of determining taxable income if the tax basis is preserved. Nevertheless, companies are required to keep another set of records known as 704 (b) books. These books are compiled in accordance with the regulations that are outlined in section 704. (b).

When it comes to taxes of partnerships, one of the most important aspects is maintaining accurate records of the partners' capital accounts. All of the tax specialists are required to report the company's and taxing parties' respective financial situations in a manner that is suitable. It is essential for tax professionals who deal with partnerships and LLCs to have a solid understanding of the reporting distinctions between the two entities.

GAAP vs 704 B

The main difference between GAAP and 704 B is that GAAP balances reflect compliance with accounting board standards, but 704 B balances do not. The economic interest that a partner has in an organization is often reflected in the GAAP accounting as well. Alternatively, 704B balances provide a partner's capital balance in a manner that is compliant with the rules of federal income tax and include both profits and losses.

The use of GAAP (Generally Accepted Accounting Principles) capital accounting is required by the Financial Accounting Standards Board (FASB). The generally accepted accounting principles do not apply to partnerships that are registered but are not publicly traded. On the other hand, auditors, lenders, and other regulatory agencies often demand partnerships to keep records and accounts that are consistent with GAAP. This is the case for many partnerships. The Generally Accepted Accounting Principles, sometimes known as GAAP for its acronym in full, are typically enforced by a company with the intention of achieving a certain degree of uniformity in the financial statements that are helpful in assessing organisations for the sake of investment.

When it comes to the preparation of financial reports for stakeholders, a variety of companies follow GAAP guidelines. In contrast to 704 (b), generally accepted accounting principles (GAAP) limit the adjustment of an asset's fair market value to the occurrence of particular events that are either "book down" or "book up" occurrences. For example, when a new partner joins an existing partnership, the existing partners might choose to restate their capital account in the books. However, for practical purposes, they are permitted to document ownership in assets' appreciation that accrued prior to the partner joining the firm. This is because of the business relationship.

The profits and losses of the partnership, as well as any gains, losses, deductions, or credits, are split amongst the partners in equal proportions. as an alternative to assigning taxable income. The demand that taxable income and losses be split in the same manner is one that often appears in partnership agreements. Income distributions according to Section 704(b) are not equivalent to dividends received from the partnership. The disclosure of the substantial economic consequence of the partners' allocation is the goal of the books required by Section 704(b).

is will demonstrate that the partners have a financial stake in the firm. There is an expectation that capital accounts will be managed in accordance with specific standards that are not part of either GAAP or the tax laws. These regulations may be found in section 704(b) of the code. In order to be eligible for the safe haven, the partnership agreement stipulates that the capital accounts must be managed in accordance with the rules outlined in the sub chapter. In the event that these capital accounts are not maintained in the appropriate way during the whole of the partnership, it will be presumed that the allocations do not have a major influence on the economy. In most cases, the requirements outlined in Section 704 are presumed to have been followed by the accounting for capital (b).

For example, in accordance with section 704 (b), if one of the partners in a business partnership contributes a property so that it can be used in the operation of the business, that partner's capital account must be credited with an amount equal to the property's value according to current market conditions. Equally, in the event that the property is distributed, the capital account of the distributee has to be debited with the property's worth according to the current market. In accordance with Section 704, determining the bookkeeping obligations' appropriate fair market value does not need a special assessment (b). It is possible for all partners to reach a consensus on the fair market value for transactions involving competing parties and transactions conducted on an equal footing.

Difference Between GAAP and 704 B in Tabular Form

Parameters of Comparison GAAP 704 B
Balance indication  The criteria established by the Accounting Board are adhered to. demonstrates that a partner's balance sheet is in accordance with the principles of the federal income tax
Responsibility  The Generally Accepted Accounting Principles do not apply to partnerships that are not traded publicly but are nevertheless registered.  Every partner has an equal say in the partnership's decisions, including financial ones.
necessity  Documentation is required of many different types of partnerships.  They are required to divide their taxable income and losses in an equal manner.
Usage  The financial statements that are standard across companies that are being analyzed for investment objectives  This demonstrates the critical role that partner allocation has in the economy.
Market value  The fair market value of an item is not subject to change unless certain conditions are met.  There is no necessity to assess the worth of the commodity in the fair market.

What is GAAP?

When it comes to accounting, you are required to adhere to certain standards for the maintenance of records or the reporting of taxes. Otherwise, you run the risk of making errors that may end up costing your organization money, which is something that no one wants to happen. The Generally Accepted Accounting Principles (GAAP) are a collection of accounting standards that must be followed by many firms.

In the field of accounting, generally accepted accounting principles (GAAP) provide companies a standardized approach to the preparation of financial statements and the performance of accounting responsibilities. The generally accepted accounting principles (GAAP) make it easier for entrepreneurs and accounting experts to monitor the financial health of a company. With GAAP, it is simpler to explain a company's financial situation to other parties like banks and other financial institutions. Even though all companies are not forced to use GAAP, you should seriously consider compiling your financial statements using these principles even if your company is not compelled to use GAAP.

What exactly does "GAAP" refer to? Generally recognized accounting principles is what is meant by the abbreviation GAAP. The generally accepted accounting principles (GAAP) are a collection of guidelines, criteria, and processes that certain companies and organizations are required to implement.

In accounting, GAAP is helpful to companies since it:

  • Create accounting records out of the financial information once it has been organized.
  • Create financial statements based on a summary of the accounting records.
  • Make certain supporting financial facts available to the public

Businesses are required to record their financial information using a standardized approach under generally accepted accounting standards, which ensures they do so. Consider these guidelines to be a set of guidelines that businesses must follow in order to produce accurate financial accounts (e.g., income statement, balance sheet, and cash flow statement).

In order to comply with GAAP, you are required to organize your financial statements in the same manner from one year to the next. In addition, the structure of the financial statements should be the same as that used by other companies that adhere to GAAP.

The manner in which financial statements are written is predicated on these accounting concepts. Investors, lenders, and auditors will have an easier time collecting information about your company if it is presented in the standard format.

Accrual accounting is a requirement of GAAP and must be used. The most complicated style of accounting is known as accrual accounting, and it makes use of more sophisticated accounts than other approaches, such as accounts payable and long-term obligations.

The investor's ability to exert influence on the investee's operational and financial policies should determine the technique that is used when accounting for investments. When it comes to determining whether or not an investor's ownership position satisfies the criteria for "substantial influence" (equity) or "control," management has the final say. These ways of thinking are not negotiable (consolidation).

For instance, if the major owner of the firm relocates, the GAAP financial records may represent the FMV of the company's assets. There is a possibility that a transaction will occur that requires revisions to the buy accounting. To put it another way, this is somewhat comparable to accounts that fall under Section 704(b), but the requirements for amending them to reflect FMV in accordance with GAAP and Section 704(b) are different.

What is 704 B?

The 704(b) inside capital is derived from the partnership tax legislation, which is an essential component of the renewable tax equity transactions that take place in the United States. It is important to remember that the inside capital is a pre-tax amount that needs to be calculated before moving on to the outside capital, which is covered on a different page. The inside capital is a component of the partnership equity balance that is broken down into amounts for the tax investor and the sponsor. When you divide the equity balance account among investors, one of the most important things to do is check to see whether the balance of the account drops below zero for the partner.

This is a very important step. You may consider the inside capital account to be the whole amount of equity capital contributed by both of the investors, and you will be able to calculate the overall equity account for the partnerships. When an investment's balance reaches zero without any protection from a DRO, the amount of income that is subject to taxation rises while the amount of money left over after taxes is reduced. This page has all of the information, and the page on the inside basis and the minimal gain contains information about how to avoid the inside basis from becoming negative.

Concepts of financial accounting provide the basis of books that are created in accordance with GAAP standards. On the other hand, 704(b) books are used to highlight the economic impact of partner allocation. According to the provisions of section 704 of the rules, the management of capital accounts must be carried out in line with standards that are distinct from GAAP and tax (b).

In accordance with section 704, if one of your partners donates a property to the partnership business, you are required to include the house's fair market value in your capital account (b). In the event that the property is distributed, the distributor's capital account shall have the amount corresponding to the item's fair market value deducted from it.

The books have to be maintained according to Section 704, although there is no need for a precise assessment of the asset's fair market value. If the parties involved in the transaction are not able to reach a consensus and the transaction is one in which the parties are not related to one another, the laws permit all partners to agree on the fair market value.

Unless there is a DRO in place or the negative-sum is wanted to be recovered in accordance with a minimum advance chargeback regulation, a partner's Sec. 704(b) wealth account cannot have a negative balance. The application of GAAP to capital accounting has a negligible effect on the tax base, and capital accounts prepared in accordance with Section 704(b) are often used as a starting point for the preparation of these other accounts in practice.

Main Differences Between GAAP and 704 B in Points

  • When determining balances according to GAAP, the norms set out by the accounting board are adhered to. while 704B balances represent a partner's capital balance in line with the regulations of the federal income tax
  • The generally accepted accounting principles do not apply to partnerships that are registered but do not participate in public markets. When it comes to the profits and losses of the partnership, the partners in 704B share the same stake in each other's success or failure.
  • The maintenance of records in accordance with GAAP is often required of partnerships. In contrast to the rule of 704B, where taxable income and losses must be split proportionally, this provision is typically imposed by the partnership agreement.
  • The implementation of GAAP helps to ensure that all financial statements are consistent with one another. while section 704b serves to emphasize how important it is to properly allocate partners.
  • According to generally accepted accounting principles (GAAP), the fair market value of an asset may only be changed in certain circumstances. While Section 704 does not mandate the calculation of a property's fair market value, it does mandate that proper records be maintained (b).
  • During the liquidation process, it is necessary to divide the profits among the partners in accordance with their positive capital accounts. They are not referred to as GAAP or tax capital accounts due to the fact that they are classified under Section 704(b). In accordance with GAAP, the proceeds are split among the partners based on their respective profit and loss sharing percentages.
  • Even if it is not required to present these books on the balance of the partnership's tax return, Section 704 (b) must still be kept since it is a requirement of the tax law in general. In addition to that, the books are of use in determining the economic essence of the agreement. On the other hand, books should be kept in accordance with GAAP in order to fulfill the standards for reporting that the company must fulfill and to demonstrate coherence in the financial information that must be presented to the shareholders and any other stakeholders the company has.
  • GAAP balances report balances that comply with the requirements of the accounting board, and tax basis balances reflect a partner's capital balance in accordance with the federal income tax principles. Section 704(b) accounts reflect a partner's economic interest in the entity. GAAP balances report balances that comply with the requirements of the accounting board.


The monies should be allocated among the partners according to their positive capital accounts at the time of liquidation. Section 704 (b) capital accounts are used instead of tax or GAAP capital accounting. The earnings are distributed among the partners using the income and loss sharing ratios when GAAP is used.

Even though Section 704 (b) books are needed by tax law, they are not required to be included in the partnership's tax return balance. Second, the economic essence of the contract is assessed using data from these publications. GAAP books, on the other hand, must be maintained to ensure that the company's reporting responsibilities are met and that financial information supplied to shareholders and other stakeholders is consistent.


  1. https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/taxtm92§ion=22
  2. https://onlinelibrary.wiley.com/doi/abs/10.1506/car.24.3.1


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"Difference Between GAAP and 704 B." Diffzy.com, 2024. Sun. 03 Mar. 2024. <https://www.diffzy.com/article/difference-between-gaap-and-704-b-522>.

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