Q: I’m on the board of a small nonprofit. We have always used the accrual method of accounting for our finances. We recently were speaking with a consultant who recommendedthat we switch to a cash basis. He said it would be easier to track and would be more appropriate for us since our annual budget is less than $300,000 and we have no paid staff. While it might be easier, none of us on the board are in favor of making the switch.
We receive a few pledged grants each year, and the money does not necessarily arrive in the same fiscal year as the pledges. Similarly, we commit to making grants each year that are not necessarily paid in the same fiscal year, depending on when the awardees meet all the paperwork requirements. We also have an annual gathering in the first quarter of the year. People sometimes register for it in the previous fiscal year, which is helpful since we always have to commit funds to cover costs for this event in the previous fiscal year.
We don’t want to be one of those groups that hires a consultant and then doesn’t listen to the advice we’re paying for. But, we really would appreciate an outside opinion.
A: The advice you’ve been given is good advice – in general. A cash basis of accounting is easier. It records money as it comes in and goes out. You get a donation in June, the income is recorded in June. You pay your credit card bill in December, and your financial records show the debit in December. For small organizations, especially those without staff, a cash basis makes sense. You always know exactly how much money you have. And, it doesn’t take an accountant to manage your books. But – and there is always a but – each organization has its own unique needs that will impact the approaches it takes.
Before we talk about your organization, let’s compare cash basis with accrual. As stated above, cash basis works like a checkbook. You can only work with the cash you have in hand. An accrual basis lets you credit income when it is earned. You don’t have to wait to be paid to record it. This means if someone makes a pledge, you can count all the income at the time the pledge is made, rather than recording each payment as the pledge is paid out. Similarly, you attribute your expenses according to when they were incurred, rather than waiting to actually pay the bills. While you have to be more cognizant of what monies you actually have in hand and what you need to put aside to pay commitments that will come due, it does give you a better idea of your financial situation for budgeting purposes.
There are some definite advantages to using the accrual method. According to the Federal Accounting Standard Advisory Board (FASB), it is the generally accepted accounting principle. Another benefit to using the accrual method of accounting is that many of the states that allow you to file your Form 990 in lieu of the states’ own reporting forms for renewing the annual charitable registration expect the information to be reported using the accrual method. If your state is one of these – Florida, where I live, is – you’re already a step ahead. And, while you said you represent a small nonprofit, if you are required to do an audit, generally accepted accounting practices show a distinct preference for the accrual method.
Your financials tell the story of your organization. You want to choose the approach that makes your story better understood by more people. This is especially true because of your legal duty to make the most informed decisions possible and your financial picture is key to informing those decisions. You mention that you receive grants and make grants that do not always come in or go out in the same year as they are committed. You also sponsor an event early in the year, for which you receive paid reservations in the previous year. You find that the accrual basis tells this story better for you than would cash accounting. That is the answer for you. Another organization might feel differently. For that organization, utilizing a cash basis would be right.
If you do ultimately decide to switch, be sure to file Form 3115, Application for Change in Accounting Method, with your Form 990. And, if you have to make any financial adjustments because of the switch, you must report them in Schedule D of the 990.