Do Nonprofits Use Cash or Accrual Accounting?

Organizations must accurately track financial transactions to understand their financial health. Two primary methods exist for recording these: cash basis and accrual basis accounting. Understanding these methods is fundamental for comprehending an organization’s financial standing.

Fundamentals of Cash and Accrual Accounting

Cash basis accounting records revenue only when cash is received and expenses only when cash is paid out. This method provides a straightforward view of cash flowing in and out of an organization. For example, if a consulting firm completes a project in June but receives payment in July, the revenue is recorded in July when the cash is deposited. Similarly, an expense for office supplies is recorded when payment is made, not when the supplies are ordered or used.

In contrast, accrual basis accounting recognizes revenue when earned, regardless of when cash is received. Expenses are recorded when incurred, irrespective of when cash is paid. Using the previous example, the consulting firm records project revenue in June when the service was rendered, even if payment is received later. An expense for office supplies is recorded when supplies are received and the liability incurred, not necessarily when the bill is paid. The primary distinction between these methods lies in the timing of revenue and expense recognition.

Accounting Practices for Nonprofits

Most larger nonprofit organizations use accrual basis accounting, aligned with Generally Accepted Accounting Principles (GAAP). In the United States, GAAP for nonprofits is guided by FASB Accounting Standards Codification (ASC) Topic 958. This standard ensures consistency and transparency in nonprofit financial statements, making it easier for stakeholders to assess an organization’s financial health.

Accrual accounting is preferred for most nonprofits because it offers a comprehensive and accurate depiction of financial performance. This method matches revenues to the expenses incurred to generate them, which is important for accountability to donors, grantors, and the public. For instance, pledges of future donations are recognized as revenue when made, not when cash is received, providing a clearer picture of committed resources.

While smaller nonprofits may use cash basis accounting for internal record-keeping or tax filing, accrual is the standard for external financial reporting. Even if a small nonprofit uses cash basis internally, they often convert their financial statements to accrual for audits, grant applications, or to meet funder requirements. The IRS generally allows cash accounting for organizations with average gross receipts below a certain threshold, but larger nonprofits are often mandated to use accrual methods for compliance.

Impact on Financial Reporting and Decision-Making

The accounting method directly influences the presentation of a nonprofit’s financial statements, such as the Statement of Activities and the Statement of Financial Position. Accrual accounting offers a clearer view of an organization’s true financial health by recognizing assets like pledges receivable and liabilities such as accounts payable, which cash accounting does not capture. This comprehensive perspective aids internal decision-making, including budgeting, program evaluation, and strategic resource allocation.

External stakeholders, including donors, grantors, and creditors, rely on accrual-based financial statements to evaluate a nonprofit’s stewardship of funds, financial stability, and capacity to fulfill its mission. These statements provide information to assess performance over time and make informed decisions about supporting the organization. Conversely, cash basis accounting, while simple, might not accurately reflect an organization’s full obligations or earned revenue, leading to misinterpretations of financial performance or position, especially for organizations with significant non-cash transactions or deferred revenue and expenses.