As a nonprofit, which method of accounting is best for your organization? The key in differentiating between cash basis vs. accrual basis lies in the timing of when revenue and expenses are recorded in your accounts.
When using the cash method of accounting (or modified cash method), revenue and expenses are recognized only when money changes hands. The income is recognized when it’s received instead of when it’s earned, and the expense is recorded when the payment is disbursed, not when it’s incurred.
Accrual basis is the required method under Generally Accepted Accounting Principles (GAAP), as well as the required method of most funding sources. When using the accrual method of accounting, exchange revenue is recognized when it’s earned, unconditional contributions are recognized in full when promised, and expenses are recognized when they’re billed (but not paid). For example, when a pledge is received, the income is recognized when the pledge is made, not when the donation amount is received.
What are some of the pros and cons of each?
Cash Basis Pros:
- There is only one entry per transaction when they occur so it’s easier to use.
- Quick and straightforward.
- Provides a more realistic picture in terms of cash flow and actual money on hand.
- No adjustments are required since this method only reports the actual money received and spent.
Cash Basis Cons:
- Cash basis requires a disclaimer in year-end reports.
- Cash basis provides limited information, omitting any non-monetary events such as receipts of donated supplies.
Accrual Basis Pros:
- The accrual method provides a more complete picture of the organization’s financial status. It includes accruals, allocations, payable, receivables, outstanding obligations and pledges.
- Accrual-based accounting provides more accurate reporting since it recognizes events as they occur.
- The “rules” with accrual basis apply to all who utilize this method, so financial statements between entities are more comparative
Accrual Basis Cons:
- Accrual basis requires two entries per transaction. Plus, it may require adjustments if pledges are not fulfilled.
- Accrual basis demands more time and effort due to computing accruals and allocations.
So why should nonprofits choose accrual accounting?
Accrual accounting may take more time, however, if the nonprofit is preparing year-end financial statements, receives funding or reports to certain other constituents, this is the required method. Accrual accounting is also perfect for all nonprofits with diverse funding sources and also provides more accurate reporting, which is helpful when budgeting for the upcoming year.
If you have any questions on choosing between cash basis vs. accrual basis, contact your Henry+Horne advisor.