The nonprofit sector is complex and diverse, with many different organizations doing work in an equally wide range of fields. As a result, nonprofits are often faced with deciding whether to use cash accounting or accrual accounting methods for their books, which can have a significant impact on the amount they owe in taxes. Let’s look at how each technique works and what nonprofits should think about before making a final decision.
Should A Nonprofit Use Cash or Accrual Accounting?
As a nonprofit, you’ll need to understand the basics of both cash and accrual accounting methods. Cash accounting is a system that requires businesses to record income as it’s received, which means that nonprofits will only count funds as revenue when they’re actually in their accounts or have been deposited into them.
In contrast, with accrual accounting, nonprofits would claim all of their expenses on tax returns – regardless of whether those payments had been made yet – but also deduct any unpaid bills from future claims for reimbursement so that they don’t lose out on money owed to them by clients or partners.
Since nonprofit organizations are operational entities, cash accounting can significantly impact their financial health.
And while it’s true that accrual methods are more accurate overall, they make things even harder for nonprofits dealing with the challenges of limited resources and budgets since expenses would be claimed as revenue before the organization has received any payment. So if you manage a nonprofit, you may second guess if a tax accountant near me will help you make the right choice or whether it’s better to go with the cash accounting method.
The Accrual Accounting vs. Cash Accounting Decision For Nonprofits
Since neither option is ideal in all situations, several considerations should go into your decision about which method to use when you’re filing nonprofit taxes. Here are some factors worth thinking about:
First, consider whether or not e-filing will be available because if so, then this makes accrual-based tax returns much easier to complete accurately.
Next, consider your business’s funding sources. If you get most of your money in small chunks, then cash accounting is probably the way to go. Still, if you receive large sums from one or two donors at a time, then accrual-based tax returns will be better for ensuring that donations are recorded accurately and adequately throughout the year.
Finally, think about how much additional paperwork using accruals entails because it can lead to extra work when filing taxes, which could mean more expenses for nonprofits on top of potentially higher tax bills.
What Accounting Methods Do Nonprofits Use?
Getting familiar with both processes for your organization can help you understand the benefits and drawbacks of each method.
To determine which method is best for your organization, it’s essential to know about cash and accrual accounting methods.
- Accrual Accounting
This system is more complicated, but it allows you to detail how much your organization has earned and spent.
- Cash Accounting
This method takes a simpler approach to track the money coming into and out of an organization.
Most nonprofit organizations use the accrual accounting method to track their finances. Nonprofits need to understand both methods to identify the best fit for their organization.
Cash Method Pros and Cons
Understanding the pros and cons of each method can help you decide which is best for your nonprofit.
Advantages
- Convenience – Cash accounting is a much simpler process, and it allows you to get started quickly.
- Accounting Requirements – This method only requires the most basic bookkeeping skills, making it easier for your team members to complete their work.
- Flexibility – It’s easy to add new income or expenses with cash accounting, so the amount on record isn’t always 100% accurate. You will have enough time after the fact to fix any errors that were made in amounts entered initially since this type of system records everything at one specific point in time each month (or quarter).
Disadvantages
- Inconsistent Reporting Quality – Cash method reporting doesn’t provide consistent data over multiple periods because some months may include more transactions than others depending on how much is coming in and going out.
- Revenue Recognition – This method doesn’t recognize revenues as soon as they are earned, misleading stakeholders who expect organizations to use accrual accounting methods.
- Expense Recognition – Expenses are recorded when cash is paid instead of when the actual expense occurs since this system only considers one specific point in time each month (or quarter).
Accrual Accounting Pros and Cons
Advantages
- Accurate reports – Accrual accounting systems provide more accurate reports since they include all transactions, even if some haven’t been paid yet.
- Consistent data – This method uses consistent and comparable measures of revenue and expenses over multiple periods for better analysis.
- Early Revenue Recognition – Revenues are recognized as soon as they occur instead of when the cash is received, so there’s no lag time between earning money and recording it in your books. The same applies to recognizing expenses.
- Auditor confidence – Using this system can help improve an auditor’s ability to verify numbers because revenues and expenditures will be recorded at different times throughout the year instead of just one specific point each month (or quarter).
Disadvantages
- Time-consuming – Accrual accounting requires more time to enter each transaction and prepare reports. It also takes longer for an organization’s net position (or balance sheet) to reflect changes in assets, liabilities, and equity since all transactions aren’t recorded at the same point in time like they are with the cash method.
- Compliance Risk – Cash-based nonprofits can use funds without proper documentation of how those resources were used, creating a compliance risk if donors or government officials request such information.
- Complexity- You need more extensive bookkeeping skills with accrual accounting than with the cash method because it is necessary to track when income was earned. Expenses occurred along with recording what has been paid by your nonprofit so far during the year/period.
Final Words
Nonprofits need to consider both cash and accrual accounting methods when it comes to their financial reporting. Once you understand their pros and cons, you’ll be able to determine which is best for your organization.