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6 factors to choose the right basis of accounting for your not-for-profit

AccountingCash, accrual, modified cash or tax—which basis of accounting is best for your not-for-profit? It’s an important decision, so you should consider your options carefully. Management, stakeholders, board members, current and potential grantors, donors and creditors all rely on your financial statements to gain an understanding of your organization’s financial health.

Not-for-profit organizations have several options when choosing a basis of accounting. Here are brief descriptions of your choices:

  • Cash Basis – Cash basis financial statements present the activity of the organization based solely on cash receipts and disbursements.
  • Accrual Basis – The accrual method of accounting, more commonly referred to as generally accepted accounting principles (GAAP), reports revenues in the period earned and expenses in the period incurred.
  • Modified Cash Basis – Modified cash basis statements combine elements of cash basis and accrual accounting. Certain transactions are reported on an accrual basis and others on a cash basis (for example, liabilities may be presented, but fixed assets may not).
  • Tax Basis – Uncommon among not-for-profit organizations, the tax method of accounting would ensure the financial statements match the organization’s Form 990.

How do you decide which basis of accounting is best? Some factors to consider when making this choice include:

  • Simplicity. The cash method may be the easiest to maintain and understand. Either the money came in or it went out. There are no accruals or allocations to compute. Cash basis financial statements are most common with very small not-for-profits.
  • Savings. Cash basis financial statements may provide administrative savings. With no accruals or allocations to consider, less time is required for accounting. In addition, if the organization has a financial statement audit, there are fewer statements for an auditor to test and issue an opinion on. This would generally reduce the cost of an audit.
  • Regulatory Requirements. Do you have to use a particular basis of accounting? For example, in Minnesota, the Attorney General’s office requires not-for-profits with more than $750,000 in revenue to have audited financial statements under GAAP. The IRS also addresses accounting method in its Form 990 Instructions, so be sure to consider the tax compliance implications of your choice.
  • Organizational Documents. Like regulatory requirements, a not-for-profit’s by-laws may specify the basis of accounting the organization must use. Consider reviewing your organization’s by-laws before undergoing extensive research to make sure you have the flexibility to choose a basis of accounting.
  • Understanding of Financial Position. Financial statements prepared under GAAP typically give readers a better understanding of the financial position of the organization at year-end. GAAP-based financial statements will show payables and other outstanding obligations, as well as any committed receivables or pledges. Cash basis statements often provide limited information. For instance, a not-for-profit that receives donated supplies and materials used in its programs would not capture their value or impact to the organization using cash basis statements.
  • Established Framework. Financial statements prepared using GAAP are based on a familiar framework. Since GAAP is commonly used, it also allows for financial statement comparability. Modified cash basis financials can be presented in any format management chooses, so they may not be comparable with the statements of other organizations.

If audited GAAP financial statements are required and an organization prefers cash basis, they can make any necessary adjustments when closing the books. Likewise, an organization may find it less confusing to have their audited financial statements match their internal financial statements. Whatever basis of accounting you choose, make sure the option you select provides useful information to all stakeholders.

For more information, tools and resources to help you with the unique aspects of not-for-profit accounting, check out the AICPA Not-for-Profit Section.

Marc Kotsonas, CPA, Officer- Mahoney Ulbrich Christiansen Russ. Marc specializes in audit services for not-for-profit organizations. He is a member of the AICPA Not-for-Profit Section and has completed the Not-for-Profit Certificate II training program.

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