Cash or Accrual?
Posted on Wednesday, June 05, 2013
It is important to understand the different methods that can be used to record an organization’s revenues and expenses. There are two principal methods of accounting for nonprofits, cash and accrual, with a third type called modified cash that combines aspects of both methods. The basic difference between the cash and accrual method is whether the transaction is recorded now or later.
The cash method of accounting is the easiest and simplest because it is similar to recording transactions in your personal checkbook. Revenue is recorded when cash is received, and expenses are recorded when cash is paid out. Many nonprofits use the cash method due to its ease. This method is more comfortable for nonprofit executives that may not have a significant amount of accounting experience or resources. Because this method only records cash inflows and outflows, it is the easiest way to manage cash flows when cash is tight. Under the cash method, a pledge of $10,000 is not recorded on the organization’s books until the cash is actually received by the organization. Also under the cash method of accounting, there are no receivables, prepaids, payables, accruals or fixed assets. The only accounts on the organization’s books are cash, revenues and expenses.
The accrual method of accounting is more difficult than the cash method. The accrual method focuses on recording revenues and expenses when transactions take place, rather than when cash is exchanged. Accounts receivable and accounts payable accounts are utilized under this method to record revenue earned but not yet received and expenses incurred but not yet paid. The $10,000 pledge noted above is recorded in revenue and receivables when the organization is awarded the grant, regardless of whether the actual cash has been received. In the same manner, an expense and payable are recorded when the bill is received even if the payment will not be made until later. Because the accrual method records revenue and expenses when events actually take place, it provides a more complete picture for the entire year’s activities.
The modified cash method of accounting starts with the cash method of accounting and includes aspects of the accrual method. The most common modifications are to record payroll liabilities, fixed assets and related depreciation, and unrealized gains/losses on investments. By recording these additional items, which are usually significant to the organization, the financial picture for the year is more accurate then that provided by the cash method.
Accounting methods vary with organizations. It is more likely that organizations with smaller budgets and limited resources lean towards using the cash method; however, this is not always true. You should take into consideration the users of your financial statements in determining which method to use. Often times, large foundations and government agencies require their funding recipients to use the accrual method. Management and the board of directors also need to understand the method being used so that they have an accurate view of the organization for budgeting and decision making.
It is up to the organization to decide the best method to be used. The method selected should be used consistently and only rarely changed.
Posted by: Carrie Minnich, CPA
Posted in Mission Minded Nonprofits
Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.