Jitasa Nonprofit Blog

Choosing an Accounting Method

Choosing an accounting method is one of the first decisions you need to make once your nonprofit is established. There are two common types of accounting, the accrual based accounting method and the cash based accounting method. There is also a method that combines the two known as the modified accrual method. Below you'll find the details of each, along with their pros and cons.

Accrual method

This method provides a more accurate picture of your current financial condition. In this method:

  • Cash is recognized by matching revenues to expenses at the time in which the transaction occurs (rather than when payment is made or received)
  • Current cash inflows/outflows are combined with future expected cash inflows/outflows
  • Corporations usually use accrual accounting, if they elect a cash basis, they’ll end up with books/tax difference at the end of the year. 
Pros
  • Preparing monthly or quarterly financial statements on an accrual basis will give you a more accurate, complete picture of your organization's financial condition. 
Cons
  • Requires two entries per transaction
  • Many organizations do not have the resources or need to keep their books on a pure accrual basis
Cash method 
Also known as the cash receipts and disbursements method, in this method:
  • Receipts are recorded during the period they are received
  • Expenses are recorded in the period in which they are actually paid
  • Smaller businesses tend to use cash accounting 
Pros
  • cash-basis accounting is easier to use on a day-to-day basis since there are fewer transactions to track, as it requires one entry per transactions 
Cons
  • If an organization follows a purely cash-based accounting system, you must disclaim this on your year-end financial reports
Modified Accrual 
Is a hybrid that combines accrual and cash basis accounting, in this method:

  • Revenue is recognized when it becomes available and measurable 
  • Expenditures are recognized when liabilities are incurred
  • Records small transactions (e.g., under $100) on a cash basis, but larger transactions and withheld payroll taxes on an accrual basis. 
  • Records income on a cash basis and expenses on an accrual basis. 

    This is the most conservative method for recording income and expenses, since you only report cash which has actually been received, but you include expenses whether or not they have been paid. However, many non-profits like to track pledges and/or grants receivable.
  • Most nonprofits choose a hybrid method that is compliant with GAAP at period end, but minimizes data entry requirements, and the need to disclaim your method on yearend forms.
When choosing an accounting method for your nonprofit, consider:

The amount of payables, receivables, etc. your organization has on an ongoing basis: 

  • If you have few unpaid bills, outstanding grants, or fees throughout the year, cash-basis accounting will provide essentially the same financial picture of your organization as accrual-basis, and it will be easier to use. 
The expertise and time constraints of your bookkeeping staff:

  • If you have a limited number of hours budgeted for bookkeeping & accounting staff, a modified accrual method will require slightly less time and detail. 
  • If this is not a concern for your organization, consider the accrual method which ultimately requires more expertise. 
The cash flow position of your organization:

  • If cash flow is an ongoing concern, the pure accrual method allows you to keep close track of payable and receivable accounts. 
The size of your organization's budget:

  • As the budgets of smaller organizations grow, the number of financial transactions will also grow. In this instance, it may become more important to keep track of all activity (such as pledges receivable or grants receivable). In this case, organizations will then switch to using a modified cash or accrual method. 
In Summary

Monthly or quarterly reporting can be tailored to your organization’s specific needs, and accrual accounts such as Accounts Payable, Grants Receivable, etc can be updated as required. Each month the books are kept on a cash basis; transactions are recorded as the cash transaction occurs. 

If you’re having an audit you’ll want your yearend financial reports prepared on an accrual basis according to generally accepted accounting principles (GAAP), regardless of the method you use throughout the year.  

Renata Poe Massie, Content Writer for Jitasa 

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