How to determine the right basis of accounting for nonprofit organizations.
A ‘basis of accounting’ is the methodology used to recognize revenues and expenses on financial statements. And because financial statements are a way for stakeholders to gage the financial health of the organization, nonprofits need to carefully consider which accounting basis they use and how that could change the financial statement.
This method recognizes income and expenses when they occur.
This method is straightforward, and probably the easiest to understand and maintain, which is why it’s common in small nonprofits. There are no accruals or allocations to compute, and therefore less time is required for accounting, which can potentially save on administrative expenses, and even nonprofit audit expenses.
However, cash-basis statements often provide limited information to stakeholders. For example, if a nonprofit receives a donation of supplies or materials that are then used in programs, it does not capture their value or impact.
This method, commonly referred to as generally accepted accounting principles (GAAP) recognizes income when its earned, rather than received, and expenses when they are incurred, rather than paid.
Accrual or GAAP accounting offers a more complete picture of an organization’s financial position. GAAP-based financial statements will show payables and other outstanding obligations, as well as any committed receivables or pledges.
This method of accounting does require more work – two entries per transaction and cash flow statements but can also be a regulatory requirement. Nonprofits should consider whether they are required to provide audited financial statements under GAAP.
Modified Cash Basis
The Modified Cash Basis of accounting combines elements of both cash and accrual accounting and establishes a position part way between the two methods. It has the following features:
- Records short-term items when cash levels change (the cash basis). This means that nearly all elements of the income statement are recorded using the cash basis, and that accounts receivable and inventory are not recorded in the balance sheet.
- Records longer-term balance sheet items with accruals (the accrual basis). This means that fixed assets and long-term debt are recorded on the balance sheet, and depreciation and amortization in the income statement.
The modified cash basis of accounting was developed through common usage, and as such there are no exact specifications for what is allowed. When using this basis, nonprofits should handle transactions in the same manner on a consistent basis, so the financial statements are comparable over time.
Practical Consideration: Modifications to the cash basis should have substantial support. This usually means the modification is equivalent to GAAP and the modifications taken together are logical.
The use of modified cash basis should be limited to entities whose operations are oriented toward cash receipts and disbursements, not significantly influenced by financing of sales or purchases, and relatively simple, without the complexities that require significant modifications.
The tax basis of accounting is rare for nonprofits. This method of accounting would ensure the financial statements match the organization’s Form 990.
Contact D+L for Guidance
For nearly 50 years, Dugan + Lopatka has partnered with nonprofit organizations to navigate every step of the financial journey. At D+L, our CPAs and consultants are always on the cutting edge of changes in the nonprofit sector. We understand the challenges you face—the special accounting, auditing and reporting requirements of your organization—and we use our deep expertise to deliver exceptional service tailored to your needs.